Factories indicate that production was strong in June, and the orders pipeline suggests that production will remain solid in coming months. Cost pressures appear to have eased recently.
Subcomponents of Index Signal Strength in Coming Months
The ISM manufacturing index jumped from 54.9 in May to 57.8 in June (top chart). Not only was the headline index much stronger than expected – the consensus had centered on a reading of 55.3 – but the outturn marked the tenth consecutive month in which the index has been above the demarcation line separating expansion from contraction. It was also the highest reading in the index since August 2014.
Drilling down reveals broad based strength in the factory sector in the subcomponents that measure the current state of the sector. For starters, the production subcomponent rose to 62.4 from 57.1. Fourteen industries reported growth in production in June, while only two industries (apparel, leather & allied products and textile mills) indicated that production declined last month. In addition, the employment subcomponent of the overall index rose to a 3-month high of 57.2 in June. The outturns on these subcomponents mean that manufacturing production likely rebounded in June from the 0.4 percent monthly decline that it registered in May.
Moreover, the forward-looking indicators also were strong, suggesting that manufacturing production should continue to expand in coming months. The subcomponents measuring new orders rose from an already strong reading of 59.5 in May to 63.5 in June (middle chart). Foreign sources of demand contributed to the overall strength in orders as the new export orders subcomponent came in at 59.5 in June. Not only did factories report a strong stream of new orders, but their orders backlog is also quite robust. (The "backlog of orders" subcomponent increased from 55.0 in May to 57.0 in June.) The decline in the inventories subcomponent to 49.0 in June is also "good news" for production going forward. That is, factories may need to rebuild inventories in coming months.
Cost Pressures Appear to Have Eased
Rising commodity prices earlier this year had led to some cost pressures in the nation’s factory sector. However, the "prices paid" subcomponent fell to a 7-month low of 55.0 in June (bottom chart) This drop in the index is consistent with recent behavior in many commodity prices, which have moved more or less sideways over the past few months. Petroleum prices moved significantly lower in June.
The only caveat we would note to the generally upbeat news from this morning’s ISM report is that the index has tended to overstate strength in the factory sector in recent years. For example, manufacturing production was up 1.4 percent on a year-ago basis in May, a solid number to be sure but hardly a "boom." That said, the index generally does a good job of telegraphing the direction of change. Therefore, we would look for activity in the factory sector to pick up in coming months.
