What We Learned from the February ISM Data
March 3, 2023
This week’s ISM Manufacturing and Services surveys for February provided an update on the relative activity levels of these important economic sectors. The data showed that the economic expansion continues to be led by the service sector, though the manufacturing sector did show signs of improvement. Meanwhile, the inflationary picture was less encouraging, though we are less concerned about the price growth in manufacturing than others.
The manufacturing data showed that the sector continues to shrink early in 2023. The headline index increased by 0.3 percentage points but, at 47.7 percent, remained well in contractionary territory for the third consecutive month. The weakness is broad-based; fourteen industries reported being in contraction in February against just three that were expanding.
The Production subindex fell to 47.3 percent, reaching the lowest level since the earliest months of the pandemic. Declining production is not a surprise. The New Orders index, which tends to be a good leading indicator for the Production index, has been in contraction since last September. Though new orders continued to contract in February, the index increased by 4.5 percentage points and now sits at a four-month high. This means that orders declined slower than in January, one of the few positive takeaways from the report. If this improvement continues, we may see production begin to expand in the coming months.
The 6.8 percentage point increase in the Prices index stirred up fears of renewed inflationary pressures. This was the second consecutive increase in the Prices index, bringing it into expansionary territory for the first time since September 2022. However, at this point, we are not worried about what this data portends for inflation. The continued decline in the Supplier Deliveries index to 45.2 suggests that supply chains, the disruption of which drove goods inflation as the economy reopened following the pandemic, are still functioning well. It’s possible that the increase in Prices index reflects the increase in industrial metals prices as the Chinese economy rebounds after the government abandoned the COVID Zero policy.
Turning to the Services survey, the February data showed that the non-manufacturing sector of the economy continues to expand at a robust pace. The headline index fell by a tenth of a percentage point to 55.1, beating the consensus expectation. As was the case in the manufacturing data, the headline trend in the service sector was broad-based. Thirteen industries reported being in expansion, against just four where activity contracted.
New Orders expanded at a faster pace, which should translate into better Business Activity data later this year. Employment also expanded at a faster pace, despite the much-publicized layoffs occurring across the US tech sector. The index of Prices Paid continues to show that the bulk of the inflationary pressure in the economy is still emanating from the service sector. The index slowed, however, to 65.6 from 67.8 in January. While this is significantly elevated from the pre-pandemic level, it suggests that the inflationary pressures from high wage growth are diminishing.
Both sets of survey data will be considered by the Federal Reserve when they next meet later this month. The weakness in manufacturing suggests that the increase in interest rates over the last year is impacting activity, but the inflation data shows that policymakers still have more to do to bring inflation back to the two percent target.
David Allen, CFA, CFP
Chief Investment Officer
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