Continued economic growth in 2022 will benefit a variety of industries, including fluid power. While market conditions are expected to remain positive, there are also several aspects such as supply chain disruptions and labor shortages which could influence how hydraulics and pneumatics manufacturers do business going forward.
During the National Fluid Power Association’s (NFPA) most recent economic update webinar held March 22, Eric Post, senior economist at ITR Economics, provided his firm’s outlook for the coming years and key market factors which have the potential to impact the fluid power industry.
Conflict Between Ukraine and Russia
The ongoing conflict between Ukraine and Russia will have a number of impacts on global markets. Economically, higher commodity prices are likely to be seen particularly in the U.S. for oil and natural gas. Post noted that while there is domestic supply of these, the commodity world is global and because Russia is a large supplier of oil and natural gas the global market will drive up prices.
Further supply chain issues are also likely to be felt by many businesses as Ukraine and Russia are large suppliers of certain elements. Neon, for example, is sourced from Ukraine; about 50-70% of the world’s neon is sourced from the country, said Post. This is an important input for the lasers used to make semiconductor chips which could result in further manufacturing backlogs for that component and the industries relying on it such as automotive.
Prolonged inflationary pressures are possible as well due to the current combination of low interest rates and supply chain issues.
In general, there will be global economic impacts from the conflict—of course, in conjunction with the humanitarian impacts—the amount of which will be dependent upon how long it lasts and what countries are involved should fighting spread beyond Ukraine.
READ MORE: Manufacturers Do Their Part to Aid Ukraine
Supply Chains are Untangling
Although supply chain challenges are noted as a possible impact of the conflict between Ukraine and Russia, Post said the supply chain should begin to untangle itself as normal economics take over. The Purchasing Managers Index has begun to show a declining trend, indicating normalization of supply chain pressures.
He again noted this is dependent upon the situation with Ukraine and Russia but as the fog of war—hopefully—dissipates, so too will related supply chain challenges. When things normalize on the political front, it should help normalization of economics and thus supply chains.
The Manufacturing Past Utilization Rate is another indicator whose rate of change has begun moving lower. Post said this is another leading indicator of improvements to the supply chain.
Overall, economic indicators show supply chain normalization is expected as 2022 progresses. During the second half of the year more subdued inflation and normal supply chain situations are expected compared to the first half of the year.
Post said during the webinar that manufacturers should avoid panic buying. While the supply chain challenges have been wearing on business, they are expected to normalize. He did note that one aspect that will not normalize is the long-term plan related to ensuring supply chains are secure. It is not likely we will return to a completely globalized world in which everything is sourced all over the globe. Things will need to be imported and processed in the U.S. and other markets. More reshoring and nearshoring will occur, and businesses should think about how they can benefit from these changes.
Manufacturers should also ensure they have redundancies lined up so they will be prepared should other disruptions occur in the market.
Higher Interest Rates and Inflation
The Federal Reserve has begun slowly raising interest rates. Post said for businesses this means now might be a good time to make acquisitions to shore up supply chains or get into new markets because rates are still very low.
If low interest rates are an important factor for a business, he also said it might be a good time to invest in processes to help optimize efficiency. This is also a good time to ensure the right marketing materials and initiatives as well as staff are in place. ITR’s outlook macroeconomically is for a rise over the next three years, and businesses will need to be prepared to capitalize upon it.
Higher interest rates are expected going forward, making now the time to act if possible and take advantage of the currently low rates. Significant rate increases are expected in 2022, said Pos,t which has been indicated by the Federal Reserve itself. One quarter ago he said three rate increases were expected but now seven are more likely. These rate increases are considered necessary to help mitigate current inflation. Rates are not expected to skyrocket, but they are going to be higher than what is seen today and could be a pain point for some businesses.
Inflation rates are expected to come down in the second half of 2022, but rising interest rates will only do so much. Instead, Post said slowing economic growth will cause inflation to go down.
Even lower inflation rates are expected in 2023 before inflation picks up again in 2024, said Post. The U.S. is not likely to see hyperinflation as the Federal Reserve is looking to help mitigate that through interest rate increases. Supply chain normalization will help to prevent that as well. But looking into the future, the 2020s are expected to be a more inflationary decade than the 2010s he said.
A return to a highly globalized world of very low cost inputs is unlikely, and there will not be a return to loose labor markets. Reshoring and nearshoring will increase, which will aid industrial production in the U.S. and other regions which may have previously outsourced manufacturing. All of this will lead to paying higher prices for goods.
Post emphasized now is the time for businesses to invest in improving their efficiencies. Once costs go up, it may be harder to do so and passing along increased costs to customers may not be possible. So it will be important to focus in on a business’ competitive advantages and optimize efficiency.
Labor Shortages will Remain a Challenge
Post said labor shortage is the number one issue ITR is concerned about, which is not expected to end anytime soon. When looking at the 12-month moving average of job openings by industry, he said the U.S. is getting uncomfortably close to 1 million openings on an annual basis in manufacturing. This is well above pre-COVID levels. The same can be seen in warehousing and some other sectors.
The economy has reached a point where there is too much demand and not enough workers willing to fill that demand, said Post.
There are many factors for this. The COVID-19 pandemic is of course one of them. While there have been improvements, it is still an ongoing pandemic which causing people to become sick as well as fear for many of becoming sick.
Demographics are a large factor as well. Baby Boomers are retiring and fewer people from younger generations are entering the field to take their place. There is a mismatch between what workers want and what employers want—particularly with blue collar jobs—which is leading to high job opening rates. Childcare also continues to be an issue for many.
All of these factors are creating a tight labor market, which Post said ITR does not foresee changing in a meaningful way over the next few years. This again makes it important for businesses to be investing in efficiency improvements now.
One positive is quit rates are going to be coming down. The labor market will continue to be tight, but as quit rates decline it should slightly ease pressure on employment costs for businesses. There will not be as dramatic a rise in wages like what was seen in 2021, but wages will keep rising.
Improving efficiencies will remain necessary to compensate for the tight labor market. Post said companies need to learn to do more with fewer workers and will not be able to hire their way out of production or distribution situations anymore.
He noted that while pay is important, so is company culture and retention; businesses need to keep these aspects in mind both to attract and keep employees.
Macroeconomic Trends
Twelve out of 12 leading indicators are declining, but it is a relatively mild decline to date said Post. This means there will decelerating growth in 2022. U.S. gross domestic product (GDP) will see its growth ease, reaching a flat level by mid-2023. The rate of growth is expected to pick up again in the second half of 2023 and into 2024.
Strong consumer spending will be the main economic driver. Retail sales are up 20.9% year-over-year and are forecast to continue at a strong rate. U.S. consumers are in a strong position as they do not have as high a debt load as in years past, enabling them to spend and put money into the economy.
Business to business spending, as measured by Nondefense Capital Goods New Orders, is tracking very well for fluid power manufacturers’ sales said Post. A double-digit growth rate can be seen in new orders and the business confidence index trend is positive as well, though future trajectories show there will be some deceleration.
ITR does not expect a recession in the near future. Spending is expected to remain positive, and the tight labor market means there will be more investment in capital equipment to produce the goods people want. Inflation will be a factor as well. As noted previously, while it is expected to go down, the market will still be more inflationary than what many are used to, which will impact the business-to-business spending trend.
Industrial Production will continue its growth trend as well, which will be good for the fluid power industry. Capital Goods, New Orders are up 15.1% year-over-year but up 11.6% on a quarterly basis, which Post said indicates a slower growth environment.
If summarizing the U.S. economy, he said businesses are in about as strong a financial position as they’ve been in the last few decades. Inflation and interest rate pressures will have their impacts, but consumers and businesses are in strong financial situations which will enable them to weather these impacts. And business opportunities will remain positive for many.
Business margins are doing well. Confidence is easing, but overall people are still placing orders, which Post said is good news for today and the future as well.
