RSM US Manufacturing Outlook Index: Four months of improvements at risk

The RSM US Manufacturing Outlook Index continues to improve, with September’s results the fourth month of a developing uptrend. Three of the five regional Federal Reserve surveys reported increased activity during the month, while the Philadelphia and Kansas City regions reported significant contractions. Nevertheless, the index moved higher to 1.6 standard deviations below zero, its highest level in the last 12 months. We note the monthly ups and downs reported by manufacturing firms. And we should point to this month’s level of activity remains lower than what would previously have been expected. But while there is still room for improvement, there have been improvements, nonetheless, and what looks to be a developing uptrend. Read more of RSM’s insights on manufacturing and the middle market. But there is also the potential that any newfound optimism and growth might meet resistance. Only the New York and Richmond regions reported moderate increases in new orders. Only 19% of manufacturing firms in the Texas have yet to notice a positive effect from the recent infrastructure bills. And there is the potential impact of the UAW strike on a wide swath of the economy. Finally, and in regard to potential long-term growth, the manufacturing surveys confirm the dampening impact of higher interest rates on capital spending and investment in technology. These monthly regional surveys of manufacturers confirm the paucity of borrowing and lending noted by quarterly surveys of financial institutions.

Increased cost of doing business

Along with this year’s decline in manufacturing activity, the surveys point to a growing reluctance to invest. We see this as a byproduct of the Federal Reserve’s 18-month rate-hike program and the risk of an induced recession. As of March 2022, the cost of short-term borrowing began moving above the extremely low rates of the previous decade. The cost of long-term corporate borrowing had also been pushed higher, to 6.4% in nominal terms, and, more important for investment decisions, to 2.7% in real (inflation-adjusted) terms. The peak in current capital spending (or expectations for spending) occurred in early 2022, just as the Federal Reserve began to hike interest rates. Since then, and with the sharp increase in real interest rates, the average monthly change in capital spending among firms has moved from highly expansionary in March 2022 to neutral in the latest survey. We expect these conditions to continue until the direction of the economy becomes clear. The Fed has stated its intentions to maintain tight money conditions to squash demand and inflation at least through the end of this year. We could expect upward pressure to continue on commercial short-term and long-term interest rates, both in nominal and real terms. This is likely to have a dampening effect on investment, which would delay further expansion.

New York

Optimism among manufacturers in New York state continues to grow, reaching its highest level in 18 months and moving above its five-year average. New orders and current shipments both increased enough during the month so that 27% of survey respondents could report increased activity against the 25% who reported decreased activity. Still, this level of optimism might not be sufficient to suggest a breakout of activity. This seems evident in the slight drops in the number of employees and hours worked, and the modest slowdown in capital spending. Regarding inflation pressures, manufacturers reported little change in the pace of input price increases and a modest pickup in the pace of selling price increases. Survey responses were collected between Sept. 5 and Sept. 12.

Philadelphia

Manufacturing activity in the Philadelphia Fed region reversed course in September, with manufacturers reporting lower current shipments, new orders and employment. Overall, manufacturing conditions are back to where they were in July, after a sharp improvement in August, as 29% of firms reported decreased activity against 16% reporting improvements. The overwhelming majority of firms, 73%, reported no change in pricing, but more than 26% reported price increases while less than 1% reported decreases. Expectations of growth were positive for the fourth month in a row, with 30% of firms expecting increased activity against only 19% that expect a decrease. Nevertheless, 45% of firms are anticipating no change over the next six months. In special questions, the median current capacity utilization rate was unchanged at 70% to 80% this quarter, with a plurality of firms reporting labor supply as a slight or moderate constraint. On the positive side, nearly 46% of the firms reported that supply chains were not a constraint to capacity utilization, up from 27% in June.

Dallas

While the perceptions of broader business conditions in Texas continued to worsen in September, the outlook for the manufacturing sector reached its highest level of the year. The new orders index pushed up but remains indicative of falling demand. The capacity utilization index rebounded into positive territory, while current shipments index rebounded to near neutral after slipping considerably in August. Labor market measures suggest stronger employment growth and longer workweeks in September. Nearly a quarter, or 23%, of firms noted net hiring, while 9% noted net layoffs. The raw materials prices index rose again this month, after trending down in the first half of the year. Finished goods prices continued to hold steady, suggesting little price growth. Responses to special questions found that government initiatives (IRA, CHIPS or the IIJA) have had a positive impact on 19% of firms. Survey results from 89 Texas manufacturers were collected Sept. 12 to 20.

Richmond

For the first time since April 2022, manufacturing activity showed signs of expansion among firms in Richmond’s Fifth District. Each of its three components of the bank’s composite activity index—shipments, new orders and employment—increased and were positive in September, though at low levels. New orders increased for the first month since March 2022. Employment growth continues to revert to neutral, while the availability of skills remains deficient. Wages continue to grow, while prices paid and received continued their downward trends. Capital expenditures and spending on equipment and software have been positive in most of the months since the worst of the pandemic. But that expansion has moderated since interest rates began to increase the cost of capital early in 2022 and now looks to be reverting to neutral. The survey was released on Sept. 26.

Kansas City

The decline in manufacturing activity in the Kansas City region was primarily driven by decreases in durable goods, particularly metal manufacturing. Most month-over-month indexes were negative and decreased from previous readings. The production, shipments and new orders indexes all declined significantly. Despite the declines, the number of employees and the average employee workweek remained steady and growth in capital expenditures increased moderately. In response to special questions in the survey, which was released Sept. 28, nearly a third of the firms reported that workers are less qualified. Additionally, over 75% of firms reported that access to credit had not changed in the past few months or over the last year. Only 13% of firms reported that access to credit had decreased in the last year. Comments for respondents to the survey included:

• “Too many unknowns currently making capital expenditures a little more risky. In addition, the cost of financing is high.”
• “Material prices continue to fall. Gasoline is our biggest inflation problem.”