U.S. manufacturing contracts again but may be on the verge of a rebound

Gerry Cantu at IMF operates a cutting machine.

BY H. Will Racke

The U.S. manufacturing sector contracted again in February — but showed signs of future renewed strength due to improving production and new orders.

The Institute for Supply Management’s latest report showed that its purchasing manager’s index (PMI), a composite indicator of manufacturing activity, rose to 49.5 from 48.2 in January. That figure indicates an overall contraction for the month, but at a slower rate than in recent months. Any measure below 50 indicates the sector is in contraction, while anything above signals expansion.

Economists surveyed by Bloomberg had forecast the index to come in at 48.5, so Tuesday’s result offered a glimmer of hope that the manufacturing sector is poised for a turnaround after five consecutive months of contraction.

“Although the February reading was still low by historic standards, it was the highest since last September and details showed 2.6 point increases in the measures of both production and employment,” J.P Morgan economist Daniel Silver wrote in a report.

The index was bolstered by a rise in new orders in 12 of 18 manufacturing industries surveyed by ISM. The new orders index for February was 51.5—the same as it was in January—indicating two consecutive months of growth.

Production expanded, as well, with that index jumping 2.6 percentage points to 52.8. According to ISM, a reading above 51.3 percent, over time, is consistent with an increase in the Federal Reserve Board’s Industrial Production figures. 10 of 18 industries showed increased production last month.

Brian Wesbury, chief economist at First Trust Advisors, saw in those forward-looking measures a potential return to stability in the manufacturing sector.

While an increase in new orders and expanding production indicated growing domestic demand, the export picture was less rosy. New export orders fell by 0.5 percentage points to 46.5, pointing to a second consecutive month of shrinking exports.

The continued strength of the U.S. dollar against certain foreign currencies makes domestically-produced goods more expensive for overseas buyers and can reduce export demand.

February’s PMI reading was one percentage point below the trailing twelve month average of 50.5 but a marked improvement over the December low of 48.0. The overall manufacturing sector began to contract in September as a sharp drop in oil and gas prices suppressed domestic demand for drilling and rig equipment. In addition, the strong U.S. dollar has put a damper on overseas demand for American-made goods.

ISM Purchasing Manager’s Index since September 2015

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February’s ISM index, released Tuesday morning, showed that the manufacturing sector contracted last month. Values above 50 indicate an expanding sector while those below 50 indicate contraction. (H. Will Racke/MEDILL)

According to World Bank data, manufacturing makes up about 12 percent of U.S. gross domestic product, down from 16 percent at the turn of this century.

Even with that diminished share, the manufacturing sector is still seen as a key measure of the health of the U.S. economy as a whole.

“The past relationship between the PMI the overall economy indicates that the average PMI for January and February (48.9 percent) corresponds to a 1.8 percent increase in real gross domestic product on an annualized basis,” wrote Bradley Holcomb, chair of the ISM Manufacturing Business Survey Committee.

“In addition, if the PMI for February (49.5 percent) is annualized, it corresponds to a 2 percent increase in real GDP annually.”

The next ISM report on manufacturing will be released April 1, 2016.

Photo at top: Gerry Cantu, lead instructor at the Illinois Manufacturing Foundation, demonstrates how to operate a single spindle screw machine. (H. Will Racke/MEDILL)