The manufacturing sector suffered an unexpected setback in February

The ISM Manufacturing Index cooled in February — a step backward relative to the recent trend of improvement in conditions in the sector. The decline to 47.8 was driven by weakness in multiple readings, most notably new orders, employment, and production. Economists had expected modest improvement for the month. 

A reading above 43 but below 50 generally indicates a slowdown in manufacturing but overall continued growth in the larger economy. The contractionary state of the manufacturing index over the last 16 months amid a consistently expansionary economy illustrates the significant and unusual divergence in spending on goods and services over the past few years.

Survey respondents indicated that new order growth softened last month, and production cooled despite relatively tight inventories. With demand weakening modestly and the pace of production slowing, fewer employers added to their payrolls last month.

For the most part, recent economic data has painted a picture of an economy that continues to expand at a solid clip, but one in which risks to continued growth remain apparent. Solid consumption growth has been fueled by persistently strong wage gains, consistent with still tight labor market conditions.

Growth has slowed considerably over the past few years but remains above trend and has even shown some signs of accelerating. Persistently solid consumption, coupled with unexpectedly strong inflation data in recent weeks, has once again raised doubts about how soon the Fed may feel comfortable enough with the inflation outlook to cut its benchmark interest rate.

Strong wage growth, particularly in the service sector, is still a potential source of concern, but one that could be mitigated with improved productivity. Moreover, the continued easing in prices paid by manufacturers should help to allay fears of a goods-based inflation in the near term.

Against that backdrop, indications that the nascent recovery in manufacturing experienced a setback last month may dampen the potential for a broad-based, near-term reacceleration in growth. More telling will be the forthcoming services index, not only because of its significance relative to the size of the economy, but also because consumers have been spending much more freely on services than goods for some time. Any signs of weakness there could indicate a broader retrenchment in consumption that isn’t limited to goods.

Perhaps February’s weaker-than-expected reading was a blip on the path back toward a stronger manufacturing economy in the coming months. Perhaps January’s relative strength was the anomaly and February’s weakness was the giveback. In either instance, one shouldn’t read too much into a single month of data.

The bottom line? Most recent macro data points to an economy that has maintained solid momentum, but the manufacturing economy continues to muddle through. The recent choppiness of the ISM data doesn’t provide a clear near-term direction for the sector, but it remains a fair distance from typical recession territory.