U.S. Manufacturing Activity Contracted Again in August; Construction Spending Unexpectedly Declined in July

• The Institute for Supply Management (ISM) manufacturing index posted a reading of 49.6 in August 2012, which was down slightly from 49.8 in the previous month and below expectations for an increase to 50.0.
• Today's report on manufacturing activity was disappointing and corroborates last week's release of the Fed's Beige Book, which pointed to a broad softening of activity in the sector across the country due to weakening demand from Europe as well as Asia. Moreover, today's report suggested that recent weakness may continue during the near term as the spread between the "new orders" and "inventories" sub-indices (considered a key indicator of future activity) fell to its lowest level since January 2009, which was the height of the recent economic downturn.
• In separate report, construction spending unexpectedly declined by 0.9% in July 2012 (market expectations were for a 0.4% increase).

Activity in the US manufacturing sector contracted for the third consecutive month in August 2012, and the pace of decline accelerated slightly as indicated by the Institute for Supply Management (ISM) manufacturing index edging down to 49.6 from 49.8 in July (a reading below 50 indicates the sector is generally contracting). The reading missed expectations for an increase in the measure to 50.0 and represented the lowest level of the index since June 2009.

The modest decline in the headline ISM index in August reflected fairly broad-based weakness across the measure's main components. The "production" sub-index moved into contractionary territory for the first time since May 2009, down 4.1 points to 47.2 in August to indicate that activity declined in the month. "New orders" contracted at a faster pace than the previous month with the component falling to 47.1 from 48.0 in August. As well, the "employment" sub-index fell for the fourth consecutive month and reached its lowest level since November 2009, although remained in expansionary territory at 51.6 in August. Partially offsetting these declines, the "inventories" component jumped to 53.0 from 49.0 in the previous month, thereby indicating that manufacturing firms' inventories are growing for the first time since September 2011, while the "supplier delivery" component rose 0.6 points to 49.3. With respect to inflationary pressures, the "prices paid" measure jumped 14.5 points to 54.0 in August as respondents indicated that the US drought was severely affecting raw materials prices in the food, beverage, and tobacco sectors.

The August report on manufacturing activity was disappointing and corroborated last week's release of the Fed's Beige Book, which pointed to a broad softening of activity in the sector across the country due to weakening demand from Europe as well as Asia. Moreover, today's report suggested that recent weakness may continue during the near term as the spread between the "new orders" and "inventories" sub-indices (considered a key indicator of future activity) fell to its lowest level since January 2009, which was the height of the recent economic downturn. Overall, today's report indicated that the manufacturing sector, which provided a key support to economic growth early in the recovery, is losing steam and supported the Fed's intention of keeping monetary policy highly accommodative for the foreseeable future.

In a separate release this morning, construction spending in the US fell by 0.9% in July 2012, widely missing market expectations for a 0.4% increase and breaking a streak of three consecutive monthly gains that saw total spending rise by an annualized 7.2% in the second quarter of 2012. The weakness in construction spending in July was broad-based, with both private (-1.2%) and public (-0.4%) sector spending down in the month. As well, overall residential (-1.6%) and non-residential (-0.6%) construction fell on a monthly basis in August.