Global research: Manufacturing cycle to peak in Q3

The global manufacturing engine has been running hot this year fuelling widespread bottlenecks and sharp increases in commodity prices and inflation. PMI levels have reached record highs.

However, after a ‘hot’ summer we believe the manufacturing cycle is set to peak during Q3 as some of the strong tailwinds behind the boom are about to fade: the boost from the record high US stimulus in Q1 is fading and the end of the pandemic in US and Europe will shift demand from goods towards services. The sharp rise in inflation also adds a negative impulse to real income growth.

A peak in the manufacturing cycle during Q3 should ease some of the current bottlenecks and reduce the inflationary pressure from commodity prices. Freight rates should also come down gradually and reach more normal levels during H1 2022.

A peak in the cycle normally points to lower returns on equities but not necessarily negative returns. It also tends to put a lid on bond yields when we have a peak in the cycle and inflation at the same time. But the expected pick-up in services and employment in H2 may change that pattern this time.

Why is the manufacturing cycle so strong?

Despite of the global pandemic raging in 2020 and 2021, the manufacturing sector has experienced the strongest boom in more than ten years. It may seem odd but a combination of strong tailwinds have been in play with the US playing a key role (for a general overview of what drives manufacturing cycles see box on page 6):

Pandemic effects on consumption: The widespread lockdowns led a to a clear shift away from service consumption to higher demand for goods, such as electronics, ‘Do- It-Yourself’ tools, fitness equipment, stuff for the home office etc. This shift has been evident across countries, not least in the US. With less money spend on travelling, eating out and other services more money was available for spending on goods. Housing also got a big boost during the pandemic in most countries fuelling demand for furniture and materials for construction of new houses, such as steel and lumber.

US consumer stimulus: In the US part of the policy response has been direct payments to consumers through stimulus checks as well as raising unemployment benefits by USD300 per week. As the top chart to the right shows, disposable income levels actually saw a big boost, which is very unusual in an economic crisis. The stimulus checks send out in March and April gave a renewed strong boost to incomes adding a renewed impetus to goods consumption as services saw widespread restrictions during spring.

Capex boom: In contrast to what we normally see in a crisis, business investments recovered very sharply after the initial plunge after COVID broke out in Q1 last year. At first, many companies needed to invest in equipment for employees working from home (lap tops, communication gear, chairs etc.). In 2021 the pressure on capacity from the manufacturing boom has also fuelled investments to increase production capacity to be able to meet demand in the future.

Going into 2021 we expected that tightening of both monetary and fiscal policy in China would weigh on global manufacturing. However, while we indeed have seen a decline in Chinese credit growth and industrial production, this has been more than compensated by the significant effects from not least the US stimulus, which have sustained the boom in global manufacturing.

The boom has been so strong that bottlenecks are now widespread, inventories got depleted and commodity prices have increased to the highest levels in many years. An attempt to rebuild inventories is also driving higher demand for materials than what is reflected by end-user demand because in order to rebuild inventories of finished goods you need to produce more than what you sell to customers. Companies also aim to stock up on materials for production where they can to avoid shortages again.

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