US manufacturing on the mend; rising raw material prices pose obstacle

General Motors assembly worker loads engine block castings on to the assembly line at the GM Romulus Powertrain plant in Romulus, Michigan, U.S. August 21, 2019. Rebecca Cook

US manufacturing grew for the first time in 1-1/2 years in March as production rebounded sharply and new orders increased, but employment at factories remained subdued amid "sizable layoff activity" and prices for inputs pushed higher. 

The survey from the Institute for Supply Management (ISM) on Monday suggested the sector, which has been battered by higher interest rates, was on the mend, though risks remain from rising raw material prices. Timothy Fiore, who chairs the ISM's manufacturing business survey committee, said "demand remains at the early stages of recovery, with clear signs of improving conditions." 

While the manufacturing rebound is a boost for the economy's growth prospects, the rise in raw material prices suggested goods inflation could pick up in the months ahead. Goods deflation was the key driver of an inflation slowdown last year. 

"If the contraction of manufacturing activity is over, far too soon to say, and price pressures are building in manufacturing, which appears to have been happening for the last three months, then this would have implications for the path for interest rates in 2024," said Conrad DeQuadros, senior economic advisor at Brean Capital. 

The ISM said its manufacturing PMI increased to 50.3 last month, the highest and first reading above 50 since September 2022, from 47.8 in February. The rebound ended 16 straight months of contraction in manufacturing, which accounts for 10.4% of the economy. That was the longest such stretch since the August 2000-January 2002 period. 

A PMI reading above 50 indicates growth in the manufacturing sector. Economists polled by Reuters had forecast the PMI would rise to 48.4. The ISM and other factory surveys had grossly overstated the weakness in manufacturing, which has been constrained by higher borrowing costs. 

Government data last week showed manufacturing output rose at an annualized rate of 0.9% in the fourth quarter. It grew 1.6% in 2023 compared to 0.8% in 2022. Though consumer spending has shifted to services, demand for goods remains supported. 

Nine industries, including textile mills, paper products, primary metals, chemical products and transportation equipment, reported growth last month. Electrical equipment, appliances and components, machinery and computer and electronic products were among the six industries reporting a contraction. 

Commentary from businesses was fairly upbeat. Makers of chemical products reported that "performance continues to defy projections of a downturn in activity," adding that "demand remains strong, and the pipeline for orders is robust." 

Transportation equipment manufacturers said they were "expecting to see orders and production pick up for the second quarter." Makers of wood products reported that "business activity is up," adding that "many manufacturers are anticipating better business in the second quarter." 

But manufacturers of machinery struck a cautious note, saying they were "noticing an increase in suppliers' selectiveness regarding orders they quote and take." Makers of paper products were worried about "energy pricing." Computer and electronic products manufacturers said "demand remains soft, but optimism is high that orders are 'just on the horizon.'" 

Financial markets expect the Federal Reserve to start cutting rates in June after hiking its policy rate by 525 basis points since March 2022 to the current 5.25%-5.50% range. 

Stocks on Wall Street were mixed. The dollar rose against a basket of currencies. US Treasury prices fell. 

NEW ORDERS REBOUND 

The ISM survey's forward-looking new orders sub-index increased to 51.4 last month from 49.2 in February. Output at factories rebounded, with the production sub-index surging to 54.6 from 48.4 in the prior month. 

There was no sign of supply chain constraints from attacks by Yemen's Houthi militants on international shipping in the Red Sea. But the ISM noted that "some suppliers are struggling to keep up." The survey's measure of supplier deliveries slipped to 49.9 from 50.1 in the prior month. A reading below 50 indicates faster deliveries. 

Nonetheless, inflation at the factory gate picked up. The survey's measure of prices paid by manufacturers rose to 55.8 from 52.5 in February, indicating raw materials prices increased last month. Twenty-four percent of companies reported higher prices compared to 18% in the prior month. 

Factory employment contracted for the sixth consecutive month, though at a moderate pace. Businesses reported continuing to reduce head counts through layoffs, which the ISM said accounted for 76% of the decline in employment, up from 50% in February. Attrition and hiring freezes were also being used by companies to trim head count. 

The survey's measure of manufacturing employment increased to 47.4 from 45.9 in February. This measure has, however, not been useful in predicting manufacturing payrolls in the government's closely watched employment report. 

Manufacturing employment has largely been treading water. Nonfarm payrolls are forecast to have increased by 200,000 jobs in March after rising by 275,000 in February, according to a Reuters survey of economists. 

While manufacturing has turned the corner, construction spending is taking a step back. A separate report from the Commerce Department on Monday showed construction spending unexpectedly dropped 0.3% in February after an unrevised 0.2% decline in January. 

Strength in single-family homebuilding, which continues to underpin construction, was more than offset by weakness in nonresidential and public projects. Economists had forecast construction spending would rebound 0.7%. 

The slump in construction spending did not dim expectations for strong growth in the first quarter, thanks to the surge in manufacturing production. 

The Atlanta Fed raised its first-quarter gross domestic product growth estimate to a 2.8% annualized rate from a 2.3% pace. The economy grew at a 3.4% rate in the fourth quarter. 

"The economy is growing solidly this spring," said Bill Adams, chief economist at Comerica Bank.