Red flags building for local manufacturing sector
Industry expected to shrink as trade conflicts cited for dim economic outlook
Manufacturing activity, slowing steadily over the past year, is forecast to begin contracting over the next three months as the outlook of companies and executives darkens, a potentially ominous sign for the Houston economy.
Manufacturing is viewed as a leading indicator, meaning its fortunes can presage the direction of economic growth. For the first time since 2017, the Houston Purchasing Managers Index, a well-regarded gauge of manufacturing based on monthly survey of local executives, predicted that growth in the sector would turn negative. Executives blamed rising costs, weakening demand and slipping prices for manufactured goods.
“What happens in Houston manufacturing has a leading relation with Houston’s broader economy,” said Jesse Thompson, a senior business economist for the Federal Reserve Bank of Dallas. “It is an important indicator of current conditions.”
Declining manufacturing activity in Houston reflects a broader industry slowdown in Texas, the nation and around the world. The national version of the Purchasing Managers Index, while still in positive territory, has fallen in each of
the past three months, reaching the lowest level since Sept. 2009, shortly after the last recession ended.
In Texas, more than half of manufacturing executives predicted that business activity would turn negative within six months, the first time that has happened since May 2016, when the oil bust was coming to an end, according to a survey by the Dallas Fed. Companies throughout Texas, particularly in manufacturing, have reported receiving fewer orders and cutting capital spending plans, which pay for expansions, new machinery and other big-ticket items.
Economists and local executives say tariffs and trade conflicts have disrupted supply chains, raised costs and left manufacturers wary of what might come next. Last year, most businesses reported in Dallas Fed surveys that tariffs on Chinese goods weren’t affecting their bottom line. Deals already in place were exempt from tariffs and many suppliers had stock in warehouses.
But now, companies throughout Texas, particularly in manufacturing, are reporting that tariffs are raising costs and shrinking orders, according to the Dallas Fed. Trade policies also are creating uncertainty, which leads businesses to move slowly or even drop plans for expansions and hiring.
Bob Driver, the president of Myrmidon Corp., a small Houston metal fabrication company, made a routine call last month to one of his steel suppliers to place an order. But his supplier, which buys metal from Mexico, was fresh out. President Donald Trump’s threats to place tariffs on Mexican goods had sparked a rush of customers trying to buy before prices spiked.
While the tariffs on Mexico were never implemented, Driver had to pay higher prices to get products from sources other than with his usual supplier.
“All of a sudden, what we normally buy wasn’t around,” Driver said. “I don’t think anyone knows what’s going to happen (with tariffs) and businesses don’t like not knowing. That’s what causes the chaos. How do you plan a business for that sort of uncertainty?”
Dark clouds
By most measures, the local, state and national economies are strong. The country is enjoying the longest economic expansion in history. Unemployment is at or near all time lows, just 3.2 percent in metropolitan Houston, 3.5 percent in Texas and 3.7 percent nationally. But economists and executives see dark clouds forming. Many economists forecast slowing growth this year and some predict a recession as early as next year. The global economy, to which much of Texas manufacturing is tied — industrial machinery is the state’s second leading export after petroleum products — is downshifting. China recently reported the weakest growth in nearly three decades while in Europe and the United States, central banks have indicated they may cut interest rates in hopes of heading off a downturn.
Manufacturing is also slowing the United States, Europe and Asia, according to several surveys. In Texas, manufacturing executives say business is softening and tariffs are cutting into their profits as they raise costs on imports and make U.S. exports less competitive in China, according to a June Dallas Fed survey. Manufacturing executives in Texas had the worst outlook for the economy since the end of the oil bust.
“Manufacturers are squeezed in terms of supply chain and customer base abroad, and I think that’s driving some of the pessimism in their outlook,” said Pia Orrenius, a senior economist at the Dallas Fed “They don’t have the profit margins to swallow that additional cost.”
The Trump administration has argued that tariffs will pay off in the longer term, ending unfair advantages exploited by China and other trading partners, opening markets and leading to more American jobs. But that has meant short-term pain for Electronic Services Unlimited Inc., a Houston company that manufactures electronic components for the the oil and gas sector.
Damien Garza, the company president, is trying to navigate the uncharted trade waters. While his company operates completely in the United States with domestic suppliers and customers, the company is still affected by the global trade tensions. His suppliers, which import the materials his company needs, started passing through the cost of tariffs as high as 25 percent this year without any warning.
The tariffs have increased the company’s material costs between 18 and 25 percent, he said. Orders, meanwhile, have slowed in the last month as the company’s oil and gas customers that import steel have cut costs elsewhere — including electronics — to offset the costs of the tariffs.
Garza added that while business has slowed in the last month, its nowhere near the dire state during the last oil bust.
“I don’t see a huge hiring spree,” Garza said, “but I’m also not seeing anyone let people go. It seems a little bit soft.”
“No logic”
A slowdown in the oil and gas sector could also be weighing on local manufacturing, which is closely tied to energy industry. Oil prices, while relatively healthy, have sputtered, largely because of concerns about weakening economic growth and energy demand. The number of operating oil rigs in the United States has declined by 96 over the past year, falling to the lowest level since the beginning of 2018, according the the Houston oilfield services company Baker Hughes.
But the longer the tariffs are in place, the more firms report uneasiness about the economy. In June, 32 percent of surveyed manufacturers in Texas reported their company outlook has diminished as a result of the tariffs, 8 percentage points higher than the same time last year. Confidence ultimately underscores company decisions to expand and hire, activities that drive broader economic growth.
Metal suppliers have responded differently to the tariffs, executives said, making it difficult for manufacturers to budget costs and adding to their uncertainty.
Some are passing the entire cost on. Others pass on only a portion of the cost. Others eat the costs and hope the tariffs just go away — though, that practice is rapidly dwindling.
“You don’t know how to approach it,” said Driver, the Myrmidon Corp. president. “There’s absolutely no logic.”
Driver, who tries to compete with Chinese manufacturers by making custom products or fulfilling small orders that are expensive to ship, said he’s escaped some of the worst effects of the tariffs because he rarely has routine orders. His nimble supply chain allows him to hunt for the best prices for each deal.
But margins are small in his business, and he worries about prices that keep going up as suppliers pass along costs.
“In manufacturing, you really have to watch your penny,” Driver said. “There isn’t 20 percent profit, and if there’s a 25 percent tariff, that’s all the profit. There’s nothing to be gained.”
“In manufacturing, you really have to watch your penny. There isn’t 20 percent profit, and if there’s a 25 percent tariff, that’s all the profit. There’s nothing to be gained.” Bob Driver, president of Myrmidon Corp., a Houston metal fabrication company