The recovery in manufacturing output has been relatively muted up to this point but, with goods consumption surging and, as a result, inventories now looking very lean for this stage in the cycle, we expect manufacturing output to climb back to its pre-pandemic level over the next few months.
- The recovery in manufacturing output has been relatively muted up to this point but, with goods consumption surging and, as a result, inventories now looking very lean for this stage in the cycle, we expect manufacturing output to climb back to its pre-pandemic level over the next few months.
- Between February and April, both goods consumption and manufacturing output fell by close to 20% peak to trough but, since lockdowns eased, goods consumption has rebounded to well above pre-pandemic levels, while output in July was still 10% below February levels. (See Chart 1.) That could be partly due to problems reopening workplaces safely, or continued supply chain disruption. But the simplest explanation is that producers were taken by surprise by the speed of the rebound in demand.
- Whatever the reason, the effect has been a contraction in business inventories rivalling the pace seen during the financial crisis. Moreover, the August ISM manufacturing index released yesterday points to a continued fall in inventories last month, suggesting manufacturers are still having a hard time catching up with demand. (See Chart 2.) Unlike in 2008 when the reduction in inventories was a needed adjustment to the persistent weakness in final sales, the drop in inventories this time around has left stock levels looking exceptionally lean. Based on the advance sales and inventories data, we estimate that the business inventory-to-sales ratio fell to a five-year low in July. (See Chart 3.)
- The breakdown shows that inventory shortages are particularly acute in sectors which have seen the biggest rebound in demand, and where restarting production involved complex cross-border supply chains. In particular, the inventory-to-sales ratio in the auto sector was at an almost-unprecedented low in June & July, and with manufacturers’ auto sales continuing to climb in August, production will need to begin rising even faster to restore more normal levels of inventory.
- The upshot is that production is likely to continue rebounding rapidly over the coming months, even as the recovery in consumption slows. Furthermore, while inventories remain so lean, we expect to see upward pressure on goods prices, particularly in the most-affected sectors like motor vehicles.
Chart 1: Durable Goods Consumption & Manufacturing Output (Feb. 20 = 100)
Chart 2: ISM Inventory Index & Business Inventories
Chart 3: Business Inventory-to-Sales Ratio (%)
Chart 4: Retail Autos Inventory-to-Sales Ratio (%)
Sources: Refinitiv, Census Bureau
Michael Pearce, Senior US Economist, +1 646 583 3163, email@example.com