Downside PMI surprises reflect rising recession risk

Services drives downside PMI surprise

Flash PMIs for May were released across advanced economies today, and signalled broadly softening growth momentum, but particularly in the services sectors of the UK and US. In the eurozone, the composite PMI moved down nearly one point to 54.9 from 55.8 in April – signalling a still-solid pace of growth – but with the services sector registering a somewhat bigger slowdown of 1.4 points. In the UK and US, much sharper slowdowns were visible, with the composite PMI plunging 6.4 points in the UK to 51.8, and the US PMI falling 2.2 points to 53.8. Similar to the eurozone, both declines were driven by downside surprises in the services sector, with manufacturing holding up rather better. The Markit press releases noted price rises and interest rate rises weighing on services demand in the US, while economic and geopolitical uncertainty was a factor in the UK, and a decline in manufacturing-related services weighed on eurozone services demand. On the positive side, survey respondents in the UK and eurozone noted continued strong demand for travel and leisure services, as economies continue to recover from the end of lockdowns. In the US and eurozone, employment indices in both manufacturing and in services also increased, with the employment component of the composite PMI in the eurozone increasing by 1.1 points to 55.9 in May, and by 0.7 points to 56.3 in the US. At this level employment indices are consistent with robust jobs growth, and besides the high stock of excess savings that accumulated during the pandemic, this should support private consumption in the coming quarters. Manufacturing sectors on both sides of the Atlantic continued to report solid expansions, although output continues to be constrained by bottlenecks and inflationary pressure.

We expect a slowdown rather than a recession, but risks are high

On the whole, PMIs continue to signal solid expansions in activity, although the bigger than expected pace of decline underlines the growing recession risk – a topic we tackle in this month’s Global Monthly. The plunge in US new home sales in April, also reported yesterday, came as an additional warning signal as it likely reflects the surge in mortgage rates over the past half year. All told, we now peg the probability of recession in advanced economies over the coming year at around 30-40%, with the inflation hit to real incomes, the threat of a Russian gas cut-off to Europe, and potentially prolonged China lockdowns the main sources of recession risk. Our base case assumes the economy will weather the hit to real incomes, as consumers dip into excess savings from the pandemic, the services sector continues to recover from the pandemic, while manufacturing should benefit from significant order backlogs in the near-term. As such, we expect headwinds to drive a significant slowdown in growth in 2023 rather than a recession. However, the downside risks to the outlook are significant. See our Global Monthly for more.