U.S. Manufacturing Surge Offsets Europe Deflation Threat

Both U.S. manufacturing and economic activity expanded in October at a much faster rate than economists expected, while a slowdown in Europe hints at an uneven global recovery.

Both U.S. manufacturing and economic activity expanded in October at a much faster rate than economists expected, while a slowdown in Europe hints at an uneven global recovery.

According to the Institute for Supply Management, manufacturing rose from the previous month as the ISM’s PMI rose to 59, up 2.4% from September’s reading of 56.6. Meanwhile, the ISM’s New Orders Index rose to 65.8, a 5.8% increase from September. The strong growth in new orders is driven by more expectations that retail spending will grow in the U.S. as many businesses prepare for the holiday season.

“Comments from the panel generally cite positive business conditions, with growth in demand and production volumes,” the ISM said in a statement.

Inventories rose to 52.5, up 1% from the prior month on muted price growth, which companies are hoping will drive more sales in the coming quarter. The ISM Prices Index fell 6% to 53.5 from the prior month, indicating deflationary pricing throughout the economy. The ISM said that seven industries, including petroleum and coal products and chemical products, were seeing lower pricing. The reading was expected, as lower oil prices cause energy costs to decline.

European Deflation Threatens Growth

While businesses in the U.S. see falling energy prices as good deflation, European economists fret that tepid price growth could cause the Eurozone to fall into a deflationary spiral.

More economists and financiers are warning that European growth is seriously threatened by the diminished monetary supply of the ECB, after its small scale QE program failed to expand the bank’s balance sheet. The so-called bond king Bill Gross, who recently left Pimco for Janus Capital Group, said that deflation is a “growing possibility” in his most recent—and first—letter with his new employer. 

“Some even argue for higher levels now that deflationary demons approach in peripheral Euroland. … Once inflation approaches zero, goes their theory, the deflationary firestorm is difficult to stop. With interest rates at zero and quantitative easing approaching potential political maximums, there is little water left to pour on the flames,” said Gross in his letter.

The Eurozone has not seen inflation at its 2% target since January 2013. Since then, inflation has decelerated almost every month, with that rate of decelerating quickening in 2014. Eurozone inflation has fallen from 0.8% in December 2013 to 0.3% in September, and some economists believe that inflation will go negative as early as the second quarter of 2015, assuming the ECB does not expand its quantitative easing program.

International Monetary Fund managing director Christine Lagarde warned at the beginning of 2014 that policymakers need to fight the “ogre” of deflation that threatened advanced economies. “If inflation is the genie, then deflation is the ogre that must be fought decisively,” she said in January.

Due to disinflation in the Eurozone and resurgent U.S. manufacturing, U.S. stocks are handily outperforming European stocks in 2014. While the S&P 500 has gained nearly 10% in 2014 so far, the Euro Stoxx 50 has lost over 10%. The German DAX index has lost over 3% while the French CAC 40 has lost 2.4%. Poor inflation outlooks have hit non-euro economies in Europe, as the FTSE 100 is down nearly 4% for the year.