Plummet in China PMI aptly reflects temporary shutdown

The dramatic decline in China’s manufacturing PMI for February from 50.0 to 35.7 and even sharper collapses in its new orders index from 51.4 to 29.3 and employment index from 47.5 to 31.8 should not come as a surprise (Charts 1 and 2). The PMI is measured to reflect companies experiencing increasing activity relative to those experiencing declining activity. Major portions of China’s manufacturing and normal economic activity have been shut down and workers are not at work. An array of anecdotal evidence is absolutely consistent with this temporary cease of normal economic activity.

Besides medical services and companies providing basic services, what companies could possibly be experiencing a pickup in activity? Perhaps more revealing than the collapse in the manufacturing PMI is the Bloomberg consensus that predicted a decline from 50 to 46. What are forecasters thinking?

As we had argued in “China’s economy: after the fall, what kind of recovery?”, the coronavirus is generating a decline in aggregate demand and aggregate supply, and leading into this shock, China’s actual economic performance was far below its official 6% growth figure. A decline does not mean slower growth; it means contraction.

A second critical point is that even if the PMI goes back up and hits 50, it means that the economy would be operating at a lower level of activity. That is, the decline from 50 to 35 is consistent with the decline to a lower level of activity. A rise back to 50 would mean that from the lower level of activity, firms are evenly split between rising and falling activity from the lower base.

Thirdly, we have emphasized that China’s manufacturing PMI has a close empirical link with global industrial production with a 3-5 month lag, reflecting China’s central role as the world’s major manufacturing hub (Chart 3). Disruptions to global supply and distribution chains are unfolding rapidly, and this should be reflected in global PMIs and industrial production. Also, the curtailment of normal activities, including travel and other services as well as the demand and production of goods, will depend upon how long it will take before the spread of the coronavirus is perceived to be ebbing.

Needless to say, central bank monetary easing will not help: real supply shocks cannot be fixed by monetary easing, particularly with monetary policies already easy and bond yields ultra-low.

On the production side, a significant unknown is whether multi-national manufacturers have sufficient inventories of components, parts and durable goods necessary to continue production. That will show up in surveys and data with a significant lag; in the meantime, anecdotal evidence is instructive.

Chart 1:

Chart 2:

Chart 3:

Mickey Levy, mickey.levy@berenberg-us.com

Member FINRA & SIPC
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