The mini-cycle in inventory has re-appeared in the latest two regional manufacturing surveys. Both the Empire Fed and Philly Fed indices have again fallen below zero, indicating a contraction in activity. However, it is the frequency of negative readings that is most relevant.

ABOOK May 2013 IP Fed Surveys Empire Philly

Since the middle of 2012, both surveys (along with their three other regional Fed cousins) have been below zero far too often to be consistent with a growing manufacturing economy. Instead, these indications look to be a part of a slow moving/developing contraction. That is consistent with other data points, particularly retail sales.

In the industrial production segment, April’s activity reported by the Fed was consistent with the declines noted in the regional surveys. Some additional mining activity offset weakness that was otherwise seen across the board. Production in the construction segment has now declined two consecutive months, confounding the housing rebound.

Growth rates in manufacturing and business equipment show fading growth rates that conform to the familiar cyclical pattern.

ABOOK May 2013 IP

In total manufacturing and business equipment production (more lagged), we see a mini-trough/rebound cycle preceding each and every recession since the double-dip of 1981-82.

ABOOK May 2013 IP Indicators

This pattern seems to be related to the modern concept of the inventory cycle and monetary policy measures. If we think of business production as the response of future expectations (I know I’m getting dangerously close to endorsing rational expectations theory here), the pre-recession pattern makes sense. The initial decline in demand first at the upper levels of the supply chain causes a drop in orders that leads, with some lag, to an initial decline in production.  That forces the entire supply chain to reassess and alter production/inventory needs.

In the recession patterns post 1980, this initial drop is accompanied by a sharp monetary policy “stimulus”, mostly in the form of reduced interest rates. If production businesses conform their expectations to textbook and mainstream economics, then this initial burst of monetary intervention buoys optimism that transforms into a rebound in activity – the expected psychology of monetarism. It is, however, short-lived since it is unsatiated by end user demand that continues to follow a lower and contracting trajectory.  In fact, monetary policy has consistently proven impotent because psychology is not the same as hard money through earned income.

ABOOK May 2013 IP Pre-recession TimingWhat we see is a consistent pre-recession pattern of initial “shock”, followed by a smaller rebound in activity, then followed by the main event. The pace of this mini-cycle has been remarkably consistent, even though its timing has not.

There is little doubt in this data that the US economy downshifted in 2012 and has yet to rebound in 2013 outside a minor bounce in inventory-related activity. Given all these trends it is difficult to see any systemic change that would force the wider economy off this contractionary path, shallow and drawn out as it has been so far. Economists may expect wonders and miracles from so much QE, but monetary stimulus has failed to change economic trajectory in every single prior case.

Perhaps this time is different given the scale of intervention, but continued bifurcation of the domestic economic system demonstrates at the very least a failure to adequately perform monetary transmission. As we have seen in Europe, the malfunctioning, credit-deprived piece eventually overwhelms any segments benefiting from monetary intrusions (at this point limited to asset prices and some housing activity that may have already run its course).