ISM: A Weakened Grip on Manufacturing Expansion

While the ISM manufacturing index remains consistent with growth in the factory sector, the fourth straight monthly decline underscores the slowing pace of expansion. West Coast port issues persist as well.

Growth at a Slower Pace

The ISM manufacturing index slipped to 52.9 in February and, while that figure still reflects an expanding manufacturing sector, it is the weakest reading since January 2014. The details of the report are consistent with a narrative of growth at a slower pace. Twelve out of 18 industries are still reporting growth.

The new orders component continues a run of more than two years in expansion territory, but February’s reading slipped four tenths of a point to 52.5. On the upside, the backlog of orders climbed back up above 50 to 51.5 after a brief stint in contraction territory the prior month.

There is nothing in this ISM report that is terribly worrying, but there are a few developments that could eventually have implications for monetary policy and are therefore worth noting. The prices index was unchanged at 35.0 but the employment component fell 2.7 points to 51.4, the softest print since 2013. We expect the FOMC to begin raising rates as early as June. We expect headline inflation to be more or less flat at that point, which is consistent with the 35.0 reading on the prices component. But we also expect firming in the labor market to be supportive of wage inflation and give the Fed confidence to raise rates even in a low-inflation environment. The employment measure, at 51.4, is still in expansion, but the decline in recent months is reason to pay close attention to labor market trends.

Both inventories (52.5) and customer inventories (46.5) increased from where they were in January. The commerce department recently slashed its estimate for Q4 inventory growth. That move alone subtracted 0.7 percentage points from the initial report for GDP growth in Q4.

Tommy Used to Work on the Docks

The import orders component slipped to 54.0 and export orders slipped further into contraction territory to 48.5, the weakest print in more than two years. While it is true that the global economic backdrop faces challenges, the weakness in these leading indicators for trade say as much about domestic labor disputes as they do about the global outlook.

Two out of three excerpts about what respondents are saying made references to the West Coast port issues. The handwringing was widespread on an industry basis, with six distinct industry categories making some observation like this one from miscellaneous manufacturing: “West Coast port congestion and work slowdowns by the union [are] hurting our imports and exports, getting worse by the week.”

We expect global economic growth to firm gradually this year, and we are calling for global GDP growth in 2016 that is in-line with the long-run average. On that basis, we would expect that once these labor disputes clear these components could retrace recent losses.