Inventory swings and roundabouts
Swings in inventories often play an amplifying role in economic cycles. In upturns, firms build inventories in anticipation of future demand, adding to headline growth. In downturns, firms seek to run down inventory levels, worsening measured GDP growth. This role as an amplifier and swing factor in economic activity makes it crucial to get a handle on inventory trends, especially when a range of idiosyncratic factors are also currently causing large inventory shifts.
The global PMIs include two series related to the stock of manufacturing inputs and finished goods. Stocks of manufacturing inputs started expanding (i.e. broke above the 50 mark) during 2017, as the global cyclical upswing was in full flow and firms were building inventories to meet future demand. The eruption of the trade war in early-2018, and the initial Brexit deadline in March 2019, further contributed to the inventory build, as firms stockpiled ahead of potential supply chain disruptions.
The upshot is that a range of economies are now operating with high levels of inventories, at the same time as underlying demand is softening. This combination is contributing to a sharp downward adjustment in inventories, as firms cut back on production and work off bloated stock levels. That in turn is exaggerating the severity of the current cyclical downswing – and will continue to weigh on growth until inventories normalise.
But the bottom line is that global economic headwinds run deeper than short-term inventory dynamics. Trade policy uncertainty and weak demand for manufactured and traded goods are weighing on growth, and are likely to continue doing so for the foreseeable future.
Chart 1: Running downSource: JP Morgan, IHS Markit, Haver, ASIRI (as of July 2019)