Recession Readiness: Cost Strategies to Take the Lead - Part I: Industry Economic Outlook

HOST: Welcome to Jerry Becker's Industrial Manufacturing Podcast. We're excited to kick off our latest series, Recession Readiness Strategies to Take the Lead, where we will discuss the current state of the economy and the risk of a recession.

HOST: We will explore strategies manufacturers can implement today to proactively rein in costs while reinvesting in growth. I'm Johanna, a partner at the firm, and I focus my practice on serving national and international industrial manufacturing clients with a focus on automotive and mobility.

HOST: Today I'm joined by Chad Mutray, chief economist of the National Association of Manufacturers (NAM). Chad also serves as director of the Center for Manufacturing Research at the Manufacturing Institute and is vice chair of the Conference of Business Economists.

HOST: He holds a PhD from Southern Illinois University and a bachelor's and master's degree in economics from Eastern Illinois University. Chad also publishes the Monday Economic Report, which I highly recommend. Welcome, Chad.

CHAD MUTRAY: That's always great to be on the podcast, Joe. Thanks for inviting me. Let's dive in.

HOST: The focus of today's podcast is to review the current economic stage and discuss future expectations regarding a potential recession. From your perspective, Chad, what is the manufacturing outlook right now?

CHAD MUTRAY: The manufacturing economy is a mix of good news and bad news. It's a much more mixed picture, similar to what you see in the press.

CHAD MUTRAY: One word I've continued to use all year in my Monday Economic Report is that manufacturing has remained pretty resilient. That's been true over the last year despite supply chain issues, inflation, and workforce challenges.

CHAD MUTRAY: Overall, manufacturing activity continues to plug along. Recent June data for manufacturing orders were strong, and core capital goods spending has been solid.

CHAD MUTRAY: Manufacturing employment remains solid; we've added 272,000 workers so far this year, and job openings continue to be substantial. Purchasing Managers' Indexes (PMIs) are still showing growth overall, even as some data weaken.

CHAD MUTRAY: On the other hand, those same PMI measures show that manufacturing activity is the weakest it has been in two years. While manufacturing is resilient, it is not immune; you are seeing weakening in new orders and exports.

CHAD MUTRAY: Another key number is that more than half of our members in the NAM Manufacturers Outlook survey in June said they expect a recession in the next year. If firms expect a downturn, they will pull back on activity, which is a red flag I have been watching.

CHAD MUTRAY: You can also see the impact of Federal Reserve policy, a weakening housing market, and some softening in consumer spending. Manufacturing continues to be resilient, but there is notable weakening to watch.

HOST: That provides a helpful overview and shows the picture is not cut and dry. To ask you directly, are we in a recession?

CHAD MUTRAY: Technically, I do not think we are in a recession. That has become a political conversation recently. We have had two consecutive quarters of declining GDP, which many learned as the definition of recession.

CHAD MUTRAY: The challenge is that if this were a recession, it would be the only recession we've ever had that is a full-employment recession. There are caveats to those numbers.

CHAD MUTRAY: In the first quarter we had negative 1.6% growth, largely due to net exports and reductions in inventories. If you looked only at consumer and business spending in the first quarter, growth would have been nearly 3%.

CHAD MUTRAY: In the second quarter, employment numbers are strong. Unemployment is 3.5 percent, near a 50-year low, and job openings remain solid. Given those factors, the National Bureau of Economic Research is unlikely to declare an official recession.

CHAD MUTRAY: I realize that to many businesses and consumers it may feel like we are in or entering a recession, and they will react accordingly. My view is we are not officially in a recession, and I do not think we will be immediately, but we could still flip into one at some point over the next year.

HOST: Moving to employment, growth, and wages, what are you hearing from NAM and your broader audience?

CHAD MUTRAY: In the NAM Manufacturers Outlook survey, the top issues are supply chain and inflation, followed by labor challenges. Members consistently report difficulty attracting and retaining workers.

CHAD MUTRAY: Competition for talent is intense across sectors. You can see high signing bonuses and elevated hourly wages in many industries, which makes competition for entry-level workers difficult.

CHAD MUTRAY: Manufacturers have told me they've raised wages two, three, sometimes four times over the past couple of years to remain competitive locally. Bureau of Labor Statistics data show average hourly earnings for production workers in manufacturing were up about 5 percent year-over-year; a few months ago that figure was 5.7 percent—the largest increase in 40 years.

CHAD MUTRAY: Job openings in manufacturing are just shy of 800,000, and we've added more than 270,000 workers this year, which is above pre-pandemic levels. It's a very tight labor market that I expect to cool somewhat over coming months, but the search for the next generation of workers is more structural than cyclical.

HOST: Clients are also discussing robotics and artificial intelligence to counter labor shortages. If you cannot get people, you must change operations.

CHAD MUTRAY: About 45 percent of our members said they've had to turn away work because they lack sufficient employees to take on new assignments. That worker shortage has a real economic impact beyond immediate productivity losses.

HOST: Besides employment, growth, and wages, what other major challenges do manufacturers face in the United States?

CHAD MUTRAY: Manufacturers report one problem after another over the past few years—the trade war in 2019, the pandemic, supply chain disruptions, inflation, and workforce shortages.

CHAD MUTRAY: Supply chain has become an umbrella term covering many issues: China's zero-COVID policy, city shutdowns in May and June that disrupted production and inputs, port congestion, the threat of a West Coast port strike, and concerns about railway strikes.

CHAD MUTRAY: There's a shortage of truck drivers and extraordinarily high freight costs, which have bitten into profits for small and medium-sized firms. Weather has also sometimes affected supply chains.

CHAD MUTRAY: In our outlook survey, in December about 54 percent of members thought supply chain issues would improve in 2022. Now a similar percentage expects improvement sometime in 2023, suggesting these issues are more stubborn and may be more permanent than hoped.

CHAD MUTRAY: Some problems, like the worker and truck shortages, are structural and will take time to resolve. The chip shortage is receiving action; President Biden signed the CHIPS Act today, which should help but will take time for facilities to come online, likely improving the situation by 2024.

HOST: Many clients are pursuing near-shoring, relocating manufacturing from Asia to North America, and asking how to do that efficiently. There are no quick fixes, and decisions made today may take two years to bear fruit.

CHAD MUTRAY: This is a unique opportunity for North America and the U.S. to attract more investment as companies seek to alleviate bottlenecks and rising freight costs.

HOST: Inflation and Federal Reserve actions are daily concerns. How do you view the Fed's measures and their effect?

CHAD MUTRAY: Inflation has become stickier than expected. Recent readings remain high; June consumer inflation was 9.1 percent year-over-year, and the producer price index is near record highs.

CHAD MUTRAY: The real worry is that companies and workers are building inflation expectations into contracts, creating a wage-price spiral that must be addressed. Core inflation on a year-over-year basis should begin to edge lower in coming months largely due to base effects from last year.

CHAD MUTRAY: July's consumer price index may decline slightly as gasoline and energy prices have fallen, but inflation will remain elevated. I expect the CPI to be roughly 6 percent year-over-year by year-end.

CHAD MUTRAY: The Fed focuses on the PCE deflator; I see core PCE pulling back to about 3.5 to 4 percent year-over-year, which is still nearly double the Fed's 2 percent target. The Fed will continue to act aggressively and has already implemented multiple 75 basis point increases.

CHAD MUTRAY: Further rate decisions will hinge on inflation data and labor market readings. I expect a 50 basis point increase in September to be likely, with the possibility of 75 depending on the data.

CHAD MUTRAY: Monetary policy takes time to affect the economy. The Fed is trying to reduce inflationary pressures without causing a recession, aiming for a soft landing. Historically, the Fed has struggled to reduce inflation without causing a downturn, and it appears willing to accept the risk of a slowdown to curb inflation.

CHAD MUTRAY: I would peg the risk of a recession over the next year around 50 percent. That risk has increased in recent months, but there remains a possibility of averting a recession.

HOST: Thank you, Chad, for your time. For our audience, please sign up for Chad's Twitter and LinkedIn feeds; his newsletter is a must-read for me every Monday.

HOST: We plan follow-up podcasts to dive deeper into operational topics such as near-shoring, automation, and efficiency improvements. We'll discuss scenario analysis, for example, what happens if you lose 10 percent of revenue and how that affects the organization.

HOST: Thanks for joining, Chad. We look forward to catching up soon on this and other topics.

CHAD MUTRAY: Thanks again for having me.