The U.S. manufacturing sector slipped closer to contractionary terrain in July, which in our estimation reaffirms the decision by the Federal Reserve to cut interest rates by 25 basis points at its July meeting on Wednesday. The top line sentiment index in the Institute for Supply Management’s manufacturing survey declined to 51.2 from 51.7 a month earlier, while production and new orders rose to 50.8 from 50 in May. Any reading below 50 in the top line is consistent with a recession in the manufacturing sector.
From our point of view, this is strongly linked to what we see as a modest inventory correction in the auto sector, issues in aerospace linked to a safety scandal at Boeing and the overall global decline in manufacturing activity connected to the trade war between the United States and China.
This is in line with our newly introduced RSM US Manufacturing Outlook Index, which has pointed to an overall decline in the manufacturing sector. It is important to note that this does not imply the U.S. economy has slipped into recession. That would be implied if the ISM manufacturing top line index falls to 43.1 or lower. While the manufacturing sector may only account for roughly 11% of GDP, it is connected to a much larger service sector ecosystem than is commonly understood and exerts a powerful impact from quarter to quarter on overall economic activity.
Index performance cools
According to the ISM report, “consumption (measured by the Production and Employment indexes) continued to expand, but at lower levels.” This resulted in a combined decrease of 6.1 percentage points to the index due to minimal new-order growth, backlog contraction and customer-inventory gains.
The ISM index has continued to cool over the past year as domestic producers struggle to react to an environment in which tariffs are increasingly playing a role in their decision making process. Manufacturers continue to examine alternative supply chains and assess their spending decisions, amid continued signs of soft global growth conditions.