The ISM Manufacturing Index eases for the seventh consecutive month

The ISM Manufacturing Index eased to 46.9 in May, fractionally weaker than the consensus forecast for a slightly more muted decline to 47.0. A reading above 50 is indicative of expansion in the manufacturing sector, while a reading below 50 is consistent with contraction. Manufacturing activity has steadily slowed since peaking in March 2021. Today’s reading puts the sector in contractionary territory for the seventh straight month.

On a positive note, factories ramped up production moderately last month, which rippled through to an increase in hiring. Manufacturing payrolls expanded for a second consecutive month on the heels of two back-to-back months of trimming. Nearly 85% of companies either maintained or added to their payrolls in May, led by transportation equipment and machinery producers.

There was also good news on prices paid that should filter through to consumers in the coming months. Raw material prices may not be falling across the board, but the nine-point decline in the index to 44.2 in May was driven by a growing number of industries that benefited from lower costs. While not an immediate benefit, the decline in raw material costs bodes well for measures of consumer inflation in the months ahead.

That’s the good news. The rest of the report was less rosy.

Manufacturer backlogs contracted at a faster pace last month as the ramp up in production chewed through a meaningful chunk of existing orders. The reading of 37.5 was the lowest in over 14 years — an exceptionally weak reading that suggests the increase in production isn’t likely to last.

The decline in backlogs was exacerbated by further weakness in demand. New orders have been contracting for nine months, but that decline accelerated sharply last month. Falling demand was relatively widespread, engulfing 12 of the 15 industries. The slowdown in the economy has been apparent for some time but has been more pronounced for goods producers in the aftermath of the consumer-driven spending binge on electronics and other goods in the early stages of the recovery. Since then, demand has shifted away from spending on “stuff,” benefiting the services sector but coming at a price for the nation’s manufacturers and goods retailers.

At just 42.6, the New Orders Index is flashing red. Historically, a decline in the New Orders Index to this level has only occurred when the economy has been at the precipice of recession. The unusually uneven nature of the recovery and the relative strength of the services sector may justify putting an asterisk on the current cycle relative to historical data. Suggestions of a rolling recession have merit, given the sharp downturn in housing and the more recent, but notable, decline in manufacturing and the demand for goods. The services sector was slower to recover and has continued to push forward despite the overall economic slowdown. Whether it can soldier on and carry the economy through until housing and manufacturing stabilize remains to be seen. The sheer size of the services sector certainly helps, but if that engine stalls, the probability of an economic soft landing will be significantly diminished. The key will be the willingness and ability of consumers to continue to spend. Falling inflation certainly helps, as does the stockpile of cash accumulated since 2020 and a labor market that has not yet buckled under the weight of massive tightening by the Fed over the past year. At some point, the impact of higher interest rates will create the slack in labor markets that the Fed is seeking to bring inflation back into line with its 2% target. Coming out of its May meeting, there was a sense of hopeful optimism that the Fed may be ready to pause at least temporarily on further rate hikes. Whether policymakers have done enough to achieve that goal remains a question. In recent weeks, there’s been a growing sense that the Fed may not yet be done after all and that another increase may be on the table in June.

The bottom line? Weak goods demand shows no sign of abating. A more pronounced decline in new orders and backlog doesn’t bode well for production or manufacturing employment in the coming months. The recession risk is real and rising, clouding the near-term outlook for manufacturing.