The ISM Manufacturing Index eased for the fifth consecutive month

The ISM Manufacturing Index eased for the fifth consecutive month, declining one point to 47.4, moderately behind consensus expectations for 48.0. The decline marked the third consecutive month in which the index was below the threshold of 50, the critical line of demarcation between expansion and contraction within the sector.

The January drop also extends a more persistent erosion in activity since the index peaked in March 2021, marking nearly two years since manufacturing growth peaked, fueled by the goods-buying consumer frenzy at the time.

Declining new orders continued to lead the index lower. At 42.5, January marked the lowest point for that index component since May 2020. Production eased moderately but appears poised to slow further in the coming months in the absence of a pronounced rebound in incoming orders.

The continued slowdown in activity corresponds with softer retail sales data in recent months and consumer demand that continues to shift from goods to services at the margins. It also confirms a broader swathe of data that points to the specter of a potential recession at some point this year.

Bucking the negative trend was better news on export orders, which may be stabilizing. Stronger overseas demand could provide a welcome source of some relief if domestic demand continues to falter.

One notable exception to the stream of negative data has been the comparative bright spot in the labor markets, where unemployment and first-time jobless claims remain quite low and openings remain elevated. The employment component of the ISM index edged lower but still points to a modest expansion in manufacturing payrolls despite the marked slowdown in other activity.

Tight labor conditions made for an exceptionally challenging hiring environment across the country since 2021, and it appears that many employers are taking a cautious approach to trimming their payrolls despite the apparent slowdown and elevated recession risk. If the outlook continues to darken, employers will eventually capitulate, but it appears that many are waiting to see the proverbial “white of the eyes” of recession before resorting to layoffs.

While still relatively solid, there are some cracks emerging in the labor economy as well. Today’s ADP report suggests that new job creation may have slowed considerably in January, but the official jobs report from the Department of Labor will provide a more conclusive picture later this week.

In the meantime, Fed Chair Jerome Powell is likely to use today’s press conference to reiterate that the Fed is still looking to create greater slack in the labor market. The Fed’s December forecast called for unemployment to rise by over one percentage point this year. While a slowdown in the pace of rate hikes is widely expected, the direction of rates appears unlikely to change until the Fed’s labor market objectives are closer to being met.

The challenge for policymakers remains the same: can they wield their relatively blunt and clumsy monetary policy tools with enough precision to create some breathing room in labor markets while guiding the economy to a soft landing? In that regard, history clearly indicates that the deck is stacked against the Fed. Once job creation turns negative and unemployment rises by 1.0%, it keeps going, rising by more than two percentage points as the economy tips into recession. Perhaps the Powell Fed will succeed where their predecessors have failed, but it will be a tall order — and one without modern precedent.

The bottom line? Continued erosion in the manufacturing sector reflects both the changing priorities for consumer spending and a widening set of data that point to weakening economic fundamentals. With the Fed seemingly committed to further tightening to create slack in the labor market, the near-term outlook for manufacturing remains challenged.