U.S. factory activity slows as clouds gather over economy

U.S. manufacturing activity slowed more than expected in June, with a measure of new orders contracting for the first time in two years, signs that the economy was cooling amid aggressive monetary policy tightening by the Federal Reserve.

The survey from the Institute for Supply Management (ISM) on Friday also showed a gauge of factory employment contracting for a second straight month, though an “overwhelming majority” of companies indicated they were hiring.

The slowdown in manufacturing followed moderate consumer spending growth in May along with weak housing starts, building permits and factory production, which left some economists anticipating that the economy contracted again in the second quarter following a slump in gross domestic product in the first three months of the year. Another decline in GDP would not necessarily indicate a recession unless the economy suffers deep job losses.

“This does not suggest that a recession is on the way yet, but growth conditions continue to decelerate broadly in response to Fed tightening and extended cost pressures for consumers and businesses,” said Ben Ayers, a senior economist at Nationwide in Columbus, Ohio.

The ISM survey’s index of national factory activity dropped to 53.0 last month, the lowest reading since June 2020, when the sector was rebounding from a COVID-19 slump. That followed a reading of 56.1 in May. The index would need to decline to 43.1 to signal a recession.

A reading above 50 indicates expansion in manufacturing, which accounts for 11.8 percent of the U.S. economy. Economists polled by Reuters had forecast the index would fall to 54.9.

U.S. manufacturing is on a better footing than factories in the eurozone and Asia. Some of the moderation in activity reflects a shift in spending back to services from goods.

All of the six largest manufacturing industries – computer and electronic products, machinery, transportation equipment, petroleum and coal products, food, and chemical products – registered moderate-to-strong growth.

“There is a risk that we talk ourselves into a recession,” said Ryan Sweet, a senior economist at Moody’s Analytics in West Chester, Pennsylvania.

Recession fears were amplified by a separate report from the Commerce Department on Friday showing construction spending unexpectedly fell in May. While the Atlanta Fed has downgraded its second-quarter GDP outlook to show a contraction, Goldman Sachs sees the economy growing at a 1.9 percent annualized rate. GDP fell at a 1.6 percent rate in the first quarter. 

Last month, the Fed raised its policy rate by three-quarters of a percentage point, its biggest hike since 1994, to quell high inflation. Another similar-sized rate hike is expected in July. The U.S. central bank has increased its benchmark overnight interest rate by 150 basis points since March.

(With input from Reuters)