Chart of the Week

THE INVENTORY CYCLE HAS BOTTOMED

The global economy seems to be perking up.

Last year was dominated by concerns that a recession would take hold in the face of surging borrowing costs and lingering inflation pressures. Yet despite significant weakness in the manufacturing and trade sectors, headline GDP rates managed to grind higher thanks to robust consumer spending.

Encouragingly, manufacturing data has come in stronger-than-expected in recent months with a pickup in the inventory cycle pointing to a sustained recovery in 2024.

The chart below measures the ratio of new goods orders to inventories in the US manufacturing sector. When it’s rising, order books are expanding faster than inventories, meaning firms need to increase production and employment to satisfy demand. This typically means the economy is in a healthy phase of growth.

The converse is true when the ratio is falling, like it did between its summer 2021 peak and late last year. This decline reflected the unwinding of the surge in demand for “stay at home” goods during the pandemic and left many firms needing to bleed down their excess stockpiles. Faced with such a demand shortfall, many manufacturing firms were forced to shut down production lines and cull their workforce; hence why a recession became the consensus call in 2023.

The good news is that manufacturing activity is finally recovering. Indeed, the recent spike in this ratio suggests firms are struggling to keep up with the increase in new orders so inventories are being depleted. That means production lines will need to be reactivated and workers rehired. In short, the manufacturing sector looks set to be a positive contributor to global growth this year.