Inquiring minds are reading the Philadelphia Fed June Business Outlook Survey for clues on the economy.

The survey’s broadest measure of manufacturing conditions, the diffusion index of current activity, decreased notably from a reading of 21.4 in May to 8.0 in June. The index, which had edged higher for four consecutive months, fell back to its lowest reading in 10 months.

Until this month, firms’ responses had been suggesting that labor market conditions were improving, but indexes for current employment and work hours were both slightly negative. For the first time in seven months, more firms reported a decrease in employment (18 percent) than reported an increase (17 percent). The largest percentage (62 percent), however, reported steady employment levels. The workweek index also declined into negative territory, its first negative reading in eight months.

Firms Report Reduced Cost Pressures

Nineteen percent of firms reported higher input prices this month, down significantly from 39 percent last month. The prices paid index decreased 26 points but remains positive, now at 10.0. On balance, firms reported declines in their own manufactured goods — slightly more firms reported decreases in their prices (15 percent) than reported increases (9 percent). The largest percentage, 71 percent, reported no change in the prices of their manufactured goods. The prices received index fell 10 points, to ‐6.5, its lowest reading in nine months.

Current Conditions vs. Expectations

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While current conditions have deteriorated rapidly, expectations six months from now are generally higher. One of these sets of numbers is wrong and my belief is expectations are way optimistic and business activity has at best stalled and more likely will soon be contracting.

Economic headwinds are enormous as noted in Fed Ponders What To Do If Recovery Fails.

Risks to Growth All on Downside

The reality is reflation has already failed and other than unsustainable government spending (and massive increases in public debt), the US economy would still be in recession.

Looking ahead, the risks to growth are all on the downside. Here are some of them.

  • China overheats and has to step on the economic brakes
  • Spain or Italy need Euro bailouts
  • Property bubbles in China, Canada, Australia pop.
  • Austerity measures throw the Eurozone back in recession
  • Huge public worker layoffs in the US
  • US housing demand weakens further, housing prices slip, construction dips, and inventory rises from already high levels
  • US unemployment starts to rise
  • UK heads bank in recession
  • Congress starts huge trade wars with China by labeling China a currency manipulator and employs large punitive tariffs

I expect everyone of those to happen with the possible exception of labeling China a currency manipulator. Thus, this is not a case of what the Fed will do “if” the recovery fails, but rather what the Fed will do “when” the recovery fails.

Bear in mind that the only semblance of economic recovery is from government spending, nearly all of it wasted or taking from future demand, thus the reflation efforts have already failed.

Finally, given an expected dramatic shift in Congress this November coupled with increasing worry over deficits and public anger over bailouts to date, reflation round two will play out much differently than did round one.

Mike “Mish” Shedlock
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