ISM: Split-Level Economy Continues, Weak Input Pricing

Manufacturing activity continued to expand but at a more moderate pace than expected as domestic production and new orders grew. Prices paid declined, indicating very little input price pressures—a plus.

Moderate Growth in the Domestic Sector

Both production (top graph) and new orders support the case for continued domestic growth in the manufacturing sector. For August, the Institute for Supply Management (ISM) index came in at 51.1 as inventory adjustments were again a drag on the index, while production and orders continue to suggest moderate growth—although a bit more moderate than anticipated. The industry comments highlighted in the report had a more positive tone than the overall index. Inventories came in at 48.5, once again below the six-month average. A stronger dollar, slower-than-expected foreign growth and lower oil prices appear to still be exerting a negative influence on the overall index through an inventory adjustment.

Employment fell to 51.2 from 52.7, suggesting some moderation in the recent gains in employment ahead. Only six of the 18 sectors reported a gain in jobs, including paper, machinery and fabricated metals as they did last month.

For the second half of 2015, industrial production is expected to grow at a pace of about 3 percent, which is more in line with 2014 compared to a weaker first half of this year.

Split Level Economy—Foreign Influences

Tepid growth overseas was manifested in another decline in the new export orders component to 46.5—a fourth-straight decline in this index (middle graph). Oil prices remain weak, which should limit production going forward. ISM moderation in 2015 relative to 2014 has accompanied weakness in equipment and nonresidential construction spending this year compared to a year ago. Only five industries reported a gain in export orders.

Prices Paid—A Plus: Lower Now for Ten Straight Months

The ISM prices index came in at 39.0 in August, 5 points lower than in July and below the six-month average (bottom graph). None of the 18 industries reported paying increased prices for raw materials. In fact, there were favorable comments that lower input prices are a plus for some firms. As for specific commodities, only plastic products were up in price. Commodities down in price include aluminum (9 straight months), stainless steel (10 months), and cold rolled steel (3 months).

Our producer price index forecast for 2015 shows continued weakness in prices for the next six months. This reflects the continued adjustment in energy prices as well as the strength of the dollar. Such moderation in commodity prices is consistent with the flat trend in consumer goods prices. The challenge for inflation remains consumer services—particularly rents and health care. This bifurcation of consumer inflation sets up a real contrast in pricing power for firms across various sectors.