Ultra State of the Economy Update: Losing Steam?

As an ERP consulting firm, we guide our clients to keep aware of the impact of economic activities, with a special focus on the U.S. Manufacturing and Distribution sector.

As the year comes to a close, it’s wise to monitor economic data and events that have major sway over the economy.

Here’s our wrap up of recent economic data and events that all serve to influence business activity.

Mediocrity Paints the Horizon

In the first half of 2018, global growth shed some of the strong momentum registered in the second half of last year, and the expansion became less synchronized across countries. Activity moderated more than expected in some large advanced economies from its strong pace last year, while the emerging market and developing economy group continued to expand at broadly the same pace as in 2017.

Among advanced economies, growth disappointed in the euro area and the United Kingdom. Slower export growth after a strong surge in the final quarter of 2017 contributed notably to the euro area slowdown. Higher energy prices helped dampen demand in energy importers, while some countries were also affected by political uncertainty or industrial actions.

Set against these developments, the US economy maintained robust growth, particularly in the second quarter, with private sector activity buoyed further by sizable fiscal stimulus. Aggregate growth in the emerging market and developing economy group stabilized in the first half of 2018.

Emerging Asia continued to register strong growth, supported by a domestic demand-led pickup in the Indian economy from a four-year-low pace of expansion in 2017, even as activity in China moderated in the second quarter in response to regulatory tightening of the property sector and nonbank financial intermediation. Higher oil prices lifted growth among fuel-exporting economies in sub-Saharan Africa and the Middle East. The recovery in Latin America continued, though at a more subdued pace than anticipated as tighter financial conditions and a drought weighed on growth in Argentina and a nationwide truckers’ strike disrupted production in Brazil.

The IMF’s Primary Commodities Price Index rose 3.3 percent between February 2018 and August 2018—that is, between the reference periods for the April 2018 and the current WEO—driven by higher energy prices displayed by the energy subindex which rose 11.1 percent. Food prices were down 6.4 percent, and the metals subindex declined 11.7 percent. Oil prices rose to more than $76 a barrel in June— the highest level since November 2014—reflecting the collapse in Venezuela’s production, unexpected outages in Canada and Libya, and expectations of lower Iranian exports following US sanctions. Prices dropped to about $71 a barrel by August following a decision by the Organization of the Petroleum Exporting Countries (OPEC) and the non-OPEC oil exporters (including Russia) to increase oil production.

The coal price index—an average of Australian and South African prices—increased 9.8 percent from February 2018 to August 2018, reflecting tight supply conditions. Strong demand for liquefied natural gas in China and India as well as higher oil prices kept the spot price for liquefied natural gas close to its highest level in three years.

Manufacturing Sector Activity

With regards to the manufacturing sector, the J.P.Morgan Global Manufacturing PMI™ fell to its lowest level in almost two years (52.1), as rates of growth in output and new orders weakened.

All three of the sub-sectors covered by the survey continued to expand in October. The bright spot was consumer goods, which saw its PMI rise to a four-month high. This contrasted with the trends in the intermediate and investment goods industries, which registered their lowest PMI readings since November 2016 and September 2016 respectively. October saw developed nations (on average) outperform emerging markets. This was mainly due to the ongoing strength of the US, which saw its PMI rise to a five-month high.

The rate of expansion hit a four-month high in Japan, which (like the US) saw above global-average growth. Rates of increase slowed to the lowest since August 2016 in the euro area and to its weakest during the current 27-month sequence of expansion in the UK. At 50.1 in October, the China PMI remained close to the stagnation mark. Growth rates hit four- and two-month highs in India and Brazil respectively, while Russia expanded for the first time since April. Among these larger emerging nations, only India registered a PMI reading above the world average.

Global Manufacturing Metrics

Global manufacturing production rose at the slowest pace in 28 months in October. Output growth was constrained by a weaker increase in new business, including a second successive month-on-month decrease in new export orders. The euro area, China, South Korea, the UK, Taiwan, Brazil, Turkey, Indonesia, Poland and Thailand all saw new export work contract. The US fared little-better, with its rate of increase in new export business easing to near-stagnation.

Among commodities affected by trade tensions, soybean prices fell in June as China announced retaliatory import tariffs on US soybeans. The softening of metals prices between February and August 2018 was largely due to weaker demand from China. Metals markets also experienced high volatility, reflecting, in part, implemented tariff actions, US sanctions on aluminum giant Rusal, and higher trade policy uncertainty. The price of iron ore, the primary input in steel manufacture, dropped 12.4 percent between the reference periods. Aluminum prices reached a seven-year high in May after the Rusal sanctions, before declining more than 10 percent in June and July as tariff hikes were implemented.

As capacity constraints tighten, the U.S. economy will rely on an expansion of imports to meet demand. Given the upward impact of tariff increases on import prices, this will add to domestic price pressures. Input price pressures are already evident, particularly for construction materials and freight transportation. So far, higher input costs have largely been absorbed by firms, although consumer price inflation has exceeded 2 per cent since November 2017. With persistent capacity constraints, a greater share of the costs can be expected to be passed on to customers, exerting upward pressure on consumer prices.

Mixed News in North America:

In the U.S., trade growth has recovered from the past appreciation of the dollar, but the outlook is uncertain as external demand is weak and the possibility exists of further trade measures being introduced. In these projections, already implemented tariff measures are assumed to remain in place, but no additional actions are taken.

The existing measures have a small upward impact on inflation and create a small drag on growth. Significant further import restraints, including raising tariffs to 25% on imports from China, would raise prices and lower GDP growth further. On a more positive note, the recent United States-Mexico-Canada Agreement reduces uncertainty for North American supply chains.

Fiscal policy loosened substantially in late 2017, as the tax reform had a depressing impact on tax revenue. Federal spending increases in 2018 and 2019 are further contributing to growing budget deficits and pushing up government debt levels. In 2020, fiscal policy becomes broadly neutral for growth as the spending increases are scaled back. Ensuring long-term fiscal sustainability is a concern and efforts to restrain spending growth and raise revenue will be important items on the future reform agenda.

Monetary policy is gradually tightening as price inflation nears the Federal Reserve’s 2% target. Inflation is projected to rise to modestly above target as economic slack disappears and prices rise somewhat due to the application of tariffs. The Federal Reserve is projected to raise interest rates to 3.5% by the end of 2019 and then keep them at that level during 2020 as the economy slows. Even with the economy slowing, monetary policy should remain contractionary as inflationary pressures intensify from the labor market. Wages are projected to pick up, rising by over 4% in 2020.

The State of Industrial Production

Industrial production edged up 0.1 percent in October, as a gain for manufacturing outweighed decreases elsewhere. As a result of upward revisions primarily in mining, the overall index is now reported to have advanced at an annual rate of 4.7 percent in the third quarter, appreciably above the gain of 3.3 percent reported initially.

Hurricanes lowered the level of industrial production in both September and October, but their effects appear to be less than 0.1 percent per month. In October, manufacturing output rose 0.3 percent for its fifth consecutive monthly increase, while the indexes for mining and for utilities declined 0.3 percent and 0.5 percent, respectively. At 109.1 percent of its 2012 average, total industrial production was 4.1 percent higher in October than it was a year earlier. Capacity utilization for the industrial sector was 78.4 percent, a rate that is 1.4 percentage points below its long-run (1972–2017) average.

The major market groups posted mixed results in October. The index for consumer goods moved up 0.2 percent, as increases for non-energy nondurables and for energy products were partly offset by a decline in consumer durables that was concentrated in automotive products. The indexes for business equipment and for defense and space equipment each advanced nearly 1 percent; both indexes have posted five consecutive months of gains.

Among nonindustrial supplies, the output of construction supplies rose about 1/2 percent in October, while the index for business supplies fell a similar amount. The output of industrial materials edged down, as gains for both durables and nondurables were outweighed by a decline for energy materials.

Manufacturing output moved up 0.3 percent in October despite a sizable drop in motor vehicle assemblies; manufacturing production excluding motor vehicles and parts increased 0.5 percent. The output of durables advanced 0.5 percent, as the indexes for most of its component industries other than motor vehicles strengthened. Nondurables posted a gain of 0.2 percent, with mixed results among its industries. The output of other manufacturing (publishing and logging) fell 1.5 percent.

Mining output declined 0.3 percent in October. After reaching an all-time high in August, primarily as a result of gains in the oil and gas sector, production slipped slightly over the past two months; the index in October was about 24 percent above its trough in 2016. The index for utilities moved down 0.5 percent in October, as a decrease for electric utilities was partially offset by a large increase for natural gas utilities.

Capacity utilization for manufacturing edged up in October to 76.2 percent—with gains for durables and nondurables and a loss for other manufacturing (publishing and logging)—but it was still 2.1 percentage points below its long-run average. The utilization rate for mining fell to 92.7 percent but remained well above its long-run average of 87.0 percent. The operating rate for utilities moved down to 77.3 percent, a rate that is 8.0 percentage points below its long-run average.

Ultra Perspective

2018 started strong but lost momentum through the second half of the year. Emerging markets maintained solid growth similar to 2017 but developed markets such as the Euro and the UK, underperformed. Much of this can be explained by higher energy prices, while some countries were also affected by political uncertainty or industrial actions.

Emerging Asia continued to register strong growth, supported by a domestic demand-led pickup in the Indian economy from a four-year-low pace of expansion in 2017, even as activity in China moderated in the second quarter in response to regulatory tightening and financial intermediation. Higher oil prices were tough on developed countries but lifted growth among fuel-exporting economies in sub-Saharan Africa and the Middle East. Additionally, the recovery in Latin America continued, though at a more subdued pace than anticipated as tighter financial conditions and a drought weighed on growth in Argentina and a nationwide truckers’ strike disrupted production in Brazil.

A bright spot, however, is the U.S. Economy. The states have maintained robust growth, particularly in the second quarter, with private sector activity buoyed further by sizable fiscal stimulus.

Fiscal policy loosened substantially in late 2017, as the tax reform had a depressing impact on tax revenue. Federal spending increases in 2018 and 2019 are further contributing to growing budget deficits and pushing up government debt levels. However, the outlook remains uncertain, as external demand is weak and the possibility exists of further trade measures being introduced. The existing measures and tariffs currently have a small upward impact on inflation and create a small drag on growth. If these policies were to be pushed further, including potential raised tariffs on imports from China, would raise prices and lower GDP growth further. Moreover, on a more positive note, the recent United States-Mexico-Canada Agreement stabilizes North American supply chains and has risen manufacturer confidence.

Losing Steam?

It seems as though 2018 really lost steam moving through the latter part of the year. This has partly been caused by political uncertainty and rapidly changing trade policies, but also by unforeseen circumstances such as natural disasters.

In this last period, the most striking comparison to note is between most developed countries and emerging markets. Higher energy prices, for example, have created great strides of growth in emerging Middle East, Latin American, and African economies while putting strain on growth in developed markets such as in Europe, Canada, and the UK. Even the U.S., which has maintained strong growth this year, is still dealing with rampant political uncertainty which makes clear predictions for future improvements extremely hard to pin down.

Trade relationships need to be solidified and re-solidified resource prices need to stabilize for us to have any idea of how to plan for the future. That’s not too much to ask for by the holidays, right?

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Jeff is the founder of Ultra Consultants, a well-known voice in the ERP consulting industry and an expert on ERP solutions for discrete and process manufacturers. Over the last 40-plus years, his companies have helped more than 2,000 organizations improve their business processes, select ERP software and implement advanced solutions.

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