The global banking system is going through some challenging conditions and the failure of several high-profile banks has the business community wondering how it will affect them. For manufacturing, the impact could be multi-dimensional.

First, manufacturers obviously rely on banks for liquidity. Prior to the start of the banking crisis in 2023, banks had already started a tightening process that was hitting the industrial production sector. The chart below using data from the Federal Reserve shows that banks have tightened credit standards for large, medium, and small industrial and commercial firms to their fourth highest levels in history. Both are now showing more than 43% of banks lending to those sectors are now tightening conditions.

Also keep in mind that these tightening conditions measures were taken from Federal Reserve surveys conducted in Q4 prior to the current mini banking crisis. As new data for Q1 is released next month, there will likely be data showing that these conditions have tightened even further amid the challenges going through the banking system.

Secondly, upstream and downstream conditions will play into manufacturer’s operations. As suppliers for manufacturers experiencing tightening of their credit conditions, they will place tougher credit standards on their manufacturing partners. That will likely push some manufacturers to improve their liquidity which could take on several different forms. They may trim inventories to free up cash, trim labor and other operating costs, or go after some higher cost borrowing to meet their liquidity needs. They may also lean on suppliers and look for more accommodative terms, especially from those suppliers with strong cash positions that will allow it (and it could give those suppliers with more accommodative terms to build some competitive advantage).

Downstream, manufacturers may put more pressure on their customers, and they may tighten credit terms to reduce their risk and exposure. Those additional costs downstream will also increase inflationary pressure overall. Costs are going to rise because of rising financial sector costs, fees, and bailout ramifications (Federal backstops that are funded by increasing costs to banks either through the FDIC system or another backstop funding mechanism – those fees eventually must be paid for by someone whether it is the taxpayer, bank, bank customer, or bank investor).

The bottom line is that there is going to be further tightening in the banking industry beyond the credit conditions tightening that has already taken place. Whether that tightening is stringent enough to shut off borrowing and eventually create a deeper risk of recession is another story altogether. Conditions are still changing, and the industry is still shaking itself out. The majority of banks are on firm footing and have strong balance sheets overall. In fact, of the 4,700 small and regional banks in the US, less than 100 are currently on a watch list of those that might have some greater risk. The industry overall is still very strong. But contagion is risky, and it drives fear into the hearts of many executives in the financial sector. That will change their psyche when it comes to lending, and what was perhaps a safe risk for them a year ago and one that would fit into their investment risk profile, may not fit in their portfolio today.

The Armada Strategic Intelligence System (ASIS) is a set of 8 predictive models covering various aspects of durable manufacturing. The capstone model is one that covers industrial production in manufacturing overall, which also includes both durable and nondurable manufacturing. Thus far, this model has performed well, coming in with 98.8% accuracy 3 months in advance and 93.3% accurate 6 months out.

The latest model output shows what many of us have feared in manufacturing, there is a swoon of sorts in the model. The model predicts that the volume of manufacturing activity (on a broad basis) is likely to be falling for the next three quarters through the end of 2023 before beginning to lift slightly in Q1 of 2024.

The long-term graph of the model shows the downturn a bit more dramatically. Although it can look a bit frightening at first blush, compared to other fluctuations over time, it is a mild downturn. We have seen similar downturns in periods between 2018 and late 2019 just prior to the pandemic. Most of us tend to look at the long term trendline (the blue dotted line) and versus what we have seen historically, this would be considered to be a recessionary prediction for the sector. But the downturn is soft. This would be akin to what many economists are predicting as a “soft landing” or “shallow recession” for the industrial production complex.

Much of this outlook depends on what happens with inventories for wholesalers, OEMs, and retailers. Too many of those sectors are sitting on inventory levels that are far too high. Coming out of December, among those industries that handle products in the United States specifically, approximately 70% of them were sitting “heavy” relative to their inventory levels in 2019. This period was just before the pandemic, and it was at the end of a ten-year period of “normalizing” inventory levels relative to sales (or better said: supply chains were optimized at that time). Companies were efficient and had their inventories tuned closely to consumption rates (not quite just-in-time but very close). Comparing them to that period is likely the most accurate for where most of them will attempt to re-adjust their ongoing inventory carrying levels to (especially with recession risk growing).

One of the important factors to understand is that these models are updated monthly. Each includes thousands of simulations that use up to 22 different economic metric inputs (modeled over 20 years) to develop these views. Although the data in the first 12 months is usually stable, the volatility shows up at the tail end of the curve between 13 and 18 months out.

Armada has other models also included in the ASIS covering predictions for automotive, aerospace, computers and electronics, machinery, electrical equipment and appliances, fabricated metals, and primary metals. Interested parties can sign up for a free trial to the ASIS (no credit card required) and the cost of subscription is inexpensive on a monthly basis and you can cancel at any time.

Over the past few decades, manufacturing jobs have been moving away from developed countries to countries with lower labor costs such as China, India, and Mexico. This offshoring trend has resulted in significant job losses and economic challenges for developed countries, particularly in the manufacturing sector. …