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The US manufacturing sector is not collapsing. But it is struggling to gain traction, and in doing so is throwing up a number of signals that, in the past, have been consistent with recession. I don't think they are telling that story this time, at least not yet. But the end of the year is looking a little more fragile than we would like it to be - and while a good part of that fragility is a consequence of the international sector, it is hard to ignore the role of fiscal policy uncertainty as a depressing force on economic activity.

Last week's advanced manufacturing report was hardly inspiring despite the ever so slight rise in core manufacturing orders:

Man5
Compared to a year ago, this data still has a recessionary feeling:

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The same holds for shipments as well, although to a lesser extent:

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Monday's ISM release confirms the softness across the manufacturing sector, with the headline number dipping below the expansion/contraction line:

Man1
While the production component rose, new orders fell, only part of which can be attributed to the international situation:

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Somewhat disconcerting is the ongoing weakness in import orders, a sign of weak domestic demand:

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And, of course, the employment component was soft as well:

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Let's hope the employment weakness is not spreading far beyond manufacturing. Note also that the softness in recent manufacturing data is carrying forward from broader third quarter trends, notably the decline in the equipment and software component of GDP:

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So while the international sector is clearly a drag, the same is increasingly true of the domestic side of the equation. This seems to be confirmed by some of the anecdotal evidence in the ISM survey, for example:

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. (Petroleum & Coal Products)

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. (Fabricated Metal Products)

The fiscal drama playing out in Washington is clearly impacting decision makers. When will this uncertainty be lifted? Calculated Risk is looking for a deal early next year, but that still leaves firms sitting on the sidelines for at least another six weeks. And note that "compromise" certainly means additional austerity. We are talking about the degree of austerity. In other words, fiscal policy will continue to be a drag into 2013. Also, Bruce Bartlett points out that the fiscal cliff is a fake problem while the real threat is the debt ceiling - read his latest on the topic and some thoughts about the implications for the president. Recall that it was the debt ceiling debate that roiled markets in the summer of 2011.

Altogether, the US economy is ending the year on a weak note, with the externally-derived weakness being compounded by expectations of further fiscal austerity and fears of severe fiscal austerity. These factors are taking the wind out of the sails of the momentum provided by improvement in the housing market:

Houst

Also note that car sales bounced back strongly in November (See Calculated Risk), a sign that the negative household spending impact of Hurricane Sandy was temporary. Unlike businesses, households have been resilient to the fiscal cliff drama; I doubt that will change unless the fears became reality and the job market turns south.

Bottom Line: 2013 is shaping up to be another slow year for the US economy. The manufacturing slowdown is real, and is being compounded by fiscal policy concerns, both real and imagined. This, of course, should be no surprise. When at the zero bound, austerity is always and everywhere an economic drag. However, it would be unusual for the US economy to slip into a recession in the midst of a housing recovery. I think the path to recession in 2013 is through the unlikely event that the worst fiscal cliff nightmares are indeed realized. That said, continuing slow growth itself would make 2013 yet another disappointing year in the recovery.

Source: Struggling To Gain Traction In Manufacturing