Demand is not the economy's problem

·3-min read

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Tuesday, August 3, 2021

A 'peak' in economic activity sounds scarier than it really is

For some time, economists and strategists have been eyeing a peak in U.S. economic growth

And manufacturing activity data released Monday suggests that time might be now — unless you look beyond the headline numbers. 

The Institute for Supply Management's manufacturing purchasing managers index (PMI) out Monday registered a reading of 59.5 for July, down from June's reading of 60.6. This data shows the manufacturing sector grew last month, albeit it at a slower pace. 

Any reading over 50 indicates the sector is growing while readings under 50 represent contraction. This report also marked the third straight month the ISM's manufacturing PMI has dropped, after peaking at 64.7 in March. 

But the headline index overlooks what the internals of this data make clear, which is that demand continues to overwhelm the supply side of the economy. 

"The ISM Manufacturing PMI was very solid under the details," said Neil Dutta, head of economics at Renaissance Macro Research. "Anyone that says anything to the contrary does not know what they are doing."

In other words, debating whether or not the economy is at, approaching, or past its moment of "peak growth" for this economic recovery doesn't help us understand what this data tells us. Firms cannot produce enough to fulfill customer orders, and inventories are being drawn down to fill the gap.  

"Business Survey Committee panelists reported that their companies and suppliers continue to struggle to meet increasing demand levels," said Timothy Fiore, chair of the ISM's manufacturing business survey committee. 

"As we enter the third quarter, all segments of the manufacturing economy are impacted by near record-long raw-material lead times, continued shortages of critical basic materials, rising commodities prices and difficulties in transporting products," Fiore added. 

"Worker absenteeism, short-term shutdowns due to parts shortages and difficulties in filling open positions continue to be issues limiting manufacturing-growth potential," he wrote.

As one business contact told the ISM: "Business levels continue to exhibit strong demand, with no signs of backing down." Additionally, data from IHS Markit published Monday indicates manufacturing activity increased at a faster pace in the U.S. last month, with this index hitting a record high. 

Michael Pearce, senior U.S. economist at Capital Economics, said Monday the ISM's report details "suggest that supply constraints, while still severe, are now beginning to ease."

"While the comments section once again reflected widespread supply problems and cost increases, the supplier deliveries time index actually edged down to 72.5, from 75.1," Pearce wrote, "and the prices paid index declined to 85.7, from 92.1, with the latter also reflecting recent declines in commodity prices" (June's prices paid index, it is worth noting, served as a record for the ISM series).

So while an overall peak in the data might appear to be emerging from headline data or sub-indexes declining slightly, there is little doubt that a demand-driven recovery that's overwhelmed global suppliers continues apace. 

And as this recovery progresses, economic data reveals time and again that the 'on/off' switch we'd hoped to flip in the spring as COVID vaccines rolled out and economic restrictions were lifted doesn't work quite so easily. 

By Myles Udland, reporter and anchor for Yahoo Finance Live. Follow him at @MylesUdland

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