In July 2011, the ISM manufacturing index fell sharply to 50.9 from 55.3 in June. This was well below market expectations for a marginal fall to 54.5, and the lowest reading since July 2009. The ISM has been above the key 50 index level for 24 consecutive months.
A breakdown of the ISM index shows that most sub-components fell during the month. In particular, the crucial New Orders component dropped by 2.4 index points to a weak 49.2 (which is the first contraction since June 2009). In addition, the Production index declined by 2.2 index points, but remained above the crucial 50 index level at 52.3, while the Employment index also fell sharply by 6.4 index points to 53.5. The rate of increase in Prices slowed for the third consecutive month.
The Institute for Supply Management surveys nearly 400 manufacturing firms on employment, production, new orders, supplier deliveries, and inventories. A composite diffusion index of national manufacturing conditions is constructed, where reading above (below) 50 percent indicate an expanding (contracting) factory sector. Export orders, import orders, backlog orders and prices paid for raw and unfinished materials are also measured, but these are not included in the overall index.
The ISM manufacturing data gives a detailed look at the manufacturing sector, how busy it is and where things are headed. Since the manufacturing sector is a major source of cyclical variability in the economy, this report has a big influence on the markets. The Federal Reserve keeps a close watch on this report. Since 1970 the ISM manufacturing index has averaged 52.6, while since 1990 the index has averaged 51.1.
According to the ISM, "Despite relief in pricing, several comments [from members] suggest a slowdown in domestic demand in the short term, while export orders continue to remain strong."
The latest slowdown in the ISM reading is clearly worrying as it suggest that the ‘soft-patch’ continues and hints that that the slowdown in the US economy could be getting worse. However, there are a couple of mitigating comments worth making:
First, the June ISM reading was much higher than expected and many of the sub-components of the index have merely reversed that gain in the July reading. Second, while there has been a sharp fall-off in the employment index in July, it remains reasonably above 50 at 53.5. Thirdly, business inventory levels have been rising sharply in the past few months, with the inventory to sales ratio tracking slightly higher; perhaps the latest ISM reading reflects some inventory adjustment (the ISM inventory index fell 4.8 index points to below 50).
Overall, although the ISM index is weak, I don’t think it is cause for panic or alarm. The employment (non-farm) payroll data is still the crucial news release to watch.
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