Manufacturing: Following The Dollar

By Jeff Harding

The ISM Manufacturing Index showed a modest gain in June, most likely reflecting some post-Tsunami inventory restocking. Exports were the main driver of the report, a result of a weak dollar for the past year. This is the 23rd month of growth in manufacturing (anything at 50+ is a positive indicator).

The Index increased from 53.5 to 55.3. Generally a reading of over 50 represents growth. The negative was that new orders barely budged, increasing only to 51.6 from May’s 51.0. One would rather see a robust new orders reading indicating strong future growth. Manufacturing employment grew also slightly from 58.2 to 59.9.

Yesterday the Chicago Fed PMI and the Kansas Fed manufacturing index also showed slight gains.

While this is a bright spot, keep looking at the trend.

It appears that with consumer demand still falling off, and consumer sentiment is still pessimistic (i.e., Gallup, Conference Board, Bloomberg, but U. of Mich./Reuters somewhat less negative). This isn’t a positive sign for manufacturing.

What seems to be driving manufacturing is this:

This chart illustrates the decline of the dollar versus the euro for the past year. The EU is not happy about this because by driving down the dollar, the Fed is, in essence, subsidizing U.S. exporters. Eurozone exports are falling off.

While this is happening, the world has been inflating their money supplies as well and are facing price inflation, a commodities boom, and housing booms (China). This is the result of worldwide monetary and fiscal stimulus. The world is reacting to these forces and tightening up money and credit. China especially is tightening. Europe is seeing price inflation and the ECB is talking about raising rates. Only Germany is experiencing strong growth. Asian economies are experiencing inflation and declining production.

This has serious implications for U.S. multinationals. If the world is cooling off, demand for U.S. goods will decline, regardless of the dollar, and that will hit these companies’ bottom line.

Another factor to watch are the PIIGS. Ignore the temporary euphoria over the potential deal worked out between Greece and the rest of the eurozone. With economies cooling worldwide, this will put the PIIGS under further pressure, especially Greece. It is still my belief that Greece will ultimately default on its debt because there is no way they will be able to repay their current and future debt obligation. In fact, according to the deal reached by the big European banks (German, French, and Belgian), Greece may already be considered to be in default because an extension of the maturity dates of their loans is considered to be a default by the rating agencies. But, neither Greece nor the banks have many alternatives for the short-term.

The fireworks with the PIIGS aren’t over and further shocks to their creditor banks will only drive cash back to U.S. Treasurys. This may boost the dollar and impact our exporters. It will be negative for Treasury prices. Such negative impacts only increase the likelihood for QE3.

These kinds of events are difficult to predict (actually any event is difficult to predict) because you never know what the central banks are going to do when crises arise. We need to keep an eye on these factors, but be aware that the odds are pretty high that they will occur.

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