The U.S. manufacturing sector contracted last month, a key measure showed Tuesday, heightening fears that the trade war with China could bring on a recession.
Manufacturing accounts for just 11% of the country’s gross domestic product, but it is often seen as an economic harbinger. Stocks fell on Wall Street after the release of the report, from the Institute for Supply Management, with the S&P 500 index closing down 0.7%.
“It was a pretty ugly report,” said Greg Daco, chief United States economist at Oxford Economics. “The headwinds that have been battering the global economy are washing up on U.S. shores.”
The institute’s manufacturing index was at 49.1 for August, down from 51.2 in July. Anything below 50 is considered a sign of contraction. The index is based on a survey of purchasing and supply managers.
Economists had expected the index to show a slight gain for August, making the drop all the more surprising and leaving the index at its lowest level since January 2016.
Several other recent indicators have suggested economic weakness. On Wall Street, short-term bond yields now exceed the return offered by longer-term notes, a sign a recession could be coming.
The institute’s survey is essentially a measure of business confidence. The latest figure echoed a University of Michigan survey released last week that showed the biggest drop in consumer confidence since 2012.
The Federal Reserve has taken note of the economic softening. The central bank in July cut its benchmark interest rate for the first time in a decade, and it is expected to cut rates again when policymakers meet in two weeks.
In a news release, the institute quoted several executives who attributed their anxieties to tariffs imposed on Chinese imports by the Trump administration. On Sunday, the United States placed a new 15% tariff on thousands of Chinese products, including some food and clothing items.
“While business is strong, there is an undercurrent of fear and alarm regarding the trade wars and a potential recession,” an unidentified executive with a chemical products company is quoted as saying. A computer and electronic products manager told the institute that “tariffs continue to be a strain on the supply chain and the economy overall.”
The Trump administration’s tariffs have affected many factory owners who depend on overseas suppliers for components and raw materials. And with Beijing imposing retaliatory tariffs on American goods, many manufacturers reliant on sales to China are feeling pain as well. All this makes manufacturers more vulnerable to trade tensions than service-economy companies.
At RJM Music in Vista, California, tariffs on LCD screens from China have increased the cost of that component by 25%, prompting a co-owner, Sheri Menelli, to rethink growth plans. Her company makes foot pedals and controllers that help guitarists integrate effects while they play, gear that it sells to rock stars and ordinary musicians.
“We’ve been eating it for the last two months,” Menelli said. “We are trying to pass it on, but you end up reducing volume.”
Buying screens from another country isn’t an option. “We’ve looked at every other LCD, but the ones we need come from China,” she said.
Menelli’s company has three full-time employees and two part-timers. She had planned to hire a third part-time employee but has decided to hold off for now.
“We keep hearing on TV that China is paying for the tariffs,” she said, referring to a statement President Donald Trump has made frequently. “I can tell you that right now I’m paying for the tariffs.”
The irony, she said, is that the duties have created an incentive for American manufacturers to move operations overseas, where they won’t be subject to tariffs for components.
“It’s already more expensive to manufacture in the U.S.,” Menelli said. “If we went to Vietnam or Thailand, then our products wouldn’t be affected by tariffs. If push comes to shove, I’ll go to Mexico or somewhere else.”
For Trump, a downturn in the production sector poses more political danger than weakness elsewhere. He has made blue-collar jobs a central image of his rallies and reelection campaign, pointing to the steel industry in particular as a symbol of American strength.
Manufacturing-heavy states of the northern Midwest delivered his unexpected victory in 2016. Any erosion in the economic fortunes of production workers could undercut his appeal to those voters.
Still, a reading below 50 on the institute’s index hardly guarantees a recession, said Jim O’Sullivan, chief United States economist at High Frequency Economics. In 2016 and 2012, it dropped to that level and no recession followed.
But O’Sullivan added that the low reading was a cause for concern. “Trade is the main source of angst in the markets right now,” he said. “There’s no question about that.”