US manufacturers struggle to grow without interest rate cuts

US manufacturers are struggling to regain momentum as the sector tries to pull out of the prolonged but shallow downturn, with any help from lower interest rates delayed due to continuing inflation in the service sector.

The desultory state of factory and freight activity has limited diesel consumption, postponed the anticipated depletion of fuel inventories, and caused refining margins to soften.

The Institute for Supply Management’s (ISM) purchasing index slipped to 47.8 (18th percentile for all months since 1980) in February down from 49.1 (25th percentile) in January.

The index has been below the 50-point threshold dividing expanding activity from a contraction for 16 months running since November 2022.

The manufacturing downturn has been the most prolonged since the slowdown of 2000-2002 and before that, 1981-1983.

Both of those downturns were cycle-ending recessions rather than mid-cycle slowdowns, characterised by a far more severe contraction in activity.

By contrast, in the current slowdown manufacturing output has declined less than 2%, according to data from the US Federal Reserve.

The worst of the current downturn was over by the second and third quarters of 2023, but manufacturers have since struggled to regain momentum.

The ISM production sub-index slipped to 48.4 (14th percentile) in February from 50.4 (22nd percentile) in January and was no higher than in July 2023.

The new orders sub-index fell to 49.2 (20th percentile) in February from 52.5 (34th percentile) in January and was no better than September 2023.

Manufacturers often find it hard to regain momentum after a mid-cycle “soft patch” – prompting the central bank to intervene by cutting interest rates.

In this instance, however, rate reductions have been postponed by residual strength in services.

Persistent inflation in the much larger and more labour-intensive services sector limits scope to provide relief for manufacturers.

Makers of expensive items such as cars, furniture and computer equipment need lower interest rates to spur household and business spending and borrowing.

But with service sector prices rising more than twice as fast as the central bank’s flexible average inflation target, policymakers have limited scope to supply more stimulus.

The central bank is confronted with a two-speed economy and cannot aid manufacturers without risking services overheating.

US consumption of diesel and other distillate fuel oils has fallen in line with the shallow but prolonged slowdown in manufacturing and freight activity.

There has been no sustained growth in distillate consumption since the middle of 2022 as the manufacturing sector has been stuck in the doldrums.

Petroleum-derived diesel consumption has actually fallen because of the small but increasing market share captured by biodiesel and renewable diesel.

The volume of petroleum-derived distillate fuel oil supplied to the domestic market (a proxy for consumption) was down to 3.6 million barrels per day (b/d) in December 2023.

The volume slipped from 3.8 million b/d in December 2022 and four million b/d in December 2021.

This is according to data from the US Energy Information Administration.

Over the same period, biodiesel and renewable diesel supplies increased to 0.3 million b/d from 0.2 million b/d in December 2022 and 0.16 million b/d in December 2021.

Despite lacklustre consumption, distillate stocks remain well below the long-term average and have shown no sign of rebuilding.

Extensive disruption of fuel manufacturing at BP’s refinery at Whiting in Indiana following a site-wide power failure has added to the diesel shortage.

US petroleum-derived distillate inventories were 15 million barrels (11% fall or 0.93 standard deviations) below the prior 10-year seasonal average on Feb 26.

The deficit had widened from 11 million barrels (8% fall or 0.77 standard deviations) at the end of 2023, according to weekly figures from the Energy Information Administration.

Distillate inventories are expected to tighten sharply once manufacturing and freight activity starts to accelerate again, putting strong upward pressure on fuel prices.

But slack industrial activity and fuel demand has pushed the expected timeframe deeper into 2024 and caused fuel prices to fall.

Prices for ultra-low sulphur diesel delivered in May 2024 are trading at a premium of around US$31 per barrel over US crude, but the premium has slid from almost US$40 in early February. — Reuters

John Kemp is a Reuters market analyst. The views expressed here are his own.