Disappointing Economic News Likely a Result of Fear of D.C.

Yesterday, the Institute for Supply Management reported that U.S. manufacturing fell to a three-year low. That's disappointing news during what, we're told, is a "recovery" from the Great Recession. Why manufacturing is shrinking again after a brief period of growth requires a bit of speculation, but comments gathered by the ISM point not just to worries over the fiscal cliff but anticipated policy choices by the federal government that have business people hunkering down for the worst.

In its report, the ISM points to raw data gathered from 18 manufacturing industries, of which 11 are contracting:

Manufacturing contracted in November as the PMI™ registered 49.5 percent, a decrease of 2.2 percentage points when compared to October's reading of 51.7 percent. This is the fourth month in the last six months that the PMI™ has contracted, and the index is at its lowest level since July 2009 when the PMI™ registered 49.2 percent. A reading above 50 percent indicates that the manufacturing economy is generally expanding; below 50 percent indicates that it is generally contracting.

The numbers aren't entirely negative. New Orders are in positive territory, despite slipping 3.9 percent since October. And Production is not just in positive territory, but actually up 1.3 percent.

However:

ISM's Employment Index registered 48.4 percent in November, which is 3.7 percentage points lower than the 52.1 percent reported in October, and is the lowest reading since September 2009 when the Employment Index registered 47.8 percent. This is the first month of contraction in employment following 37 consecutive months of growth in the Employment Index.

That's no surprise. You don't need to employ people if you're winding up production, seeing orders slip and manufacturing less.

But why the sudden fall-off in numbers? The ISM points to the reason in the opening paragraph:

Comments from the panel this month generally indicate that the second half of the year continues to show a slowdown in demand; respondents also express concern over how and when the fiscal cliff issue will be resolved.

Specifically, a representive of the Petroleum and Coal Products industry is quoted saying, "The principle business conditions that will affect the company over the next three or four quarters will be the U.S. federal government tax and budgetary policies; the impact of those policies is not yet clear." And a counterpart from Fabricated Metal Products offered, "The fiscal cliff is the big worry right now. We will not look toward any type of expansion until this is addressed; if the program that is put in place is more taxes and big spending cuts — which will push us toward recession — forget it."

You can quibble with the concern over spending cuts (I do) without detracting from the overall impression that policy uncertainty has businesses growing cautious and taking a wait-and-see strategy until they know for sure just how stupidly federal officials will deal with the financial mess. Why place orders, stockpile inventory and hold on to expensive labor if the government is likely to sabotage the works?

Much has been made in recent days of a graph from BlackRock showing that market volatility has remained low even as the Policy Uncertainty Index has trended ever-upward. The manufacturing report seems to indicate that policy worries are reflected in the economy, even if not on Wall Street.

The people in Washington, D.C. may be lousy at most things. But they can certainly muck things up.