The Institute for Supply Management (ISM) manufacturing index declined by 2.4 points in April to 54.8 – weaker than the consensus expectation of a decline to 56.5 from 57.2 in March. Still, the U.S. manufacturing sector continued to expand for the eighth consecutive month.

Moves in the subcomponents of the index were mixed, with four of the ten subcomponents rising in the month. Some of the biggest moves lower included new orders (-7.0 to 57.5), employment (-6.9 to 52.0) and prices (-2.0 to 68.5). The four subcomponents that recorded an increase include inventories (+2.0 to 51.0), imports (+2.0 to 55.5), production (+1.0 to 58.6), and new export orders (+0.5 to 59.5).

As a result of the large decline in new orders and the small increase in inventories, the spread between the two – useful as a leading indicator of activity – narrowed in April to 6.5 from 15.5 in March. This suggests that manufacturing activity is likely to expand at a more gradual pace in upcoming months.

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Of eighteen manufacturing industries, sixteen reported growth in April. Electrical equipment appliances and components, textile mills, and nonmetallic mineral products all registered the strongest rates of expansion in the month. The only industry reporting contraction in April was apparel, leather and allied products.

Key Implications

The softer reading on the manufacturing sector this morning suggests that growth or sentiment in the sector is coming back down to earth after peaking this past February. Although all subcomponents (with the exception of customers’ inventories) remain firmly in expansionary territory, the large decline in new orders and employment will likely reduce expectations of a similar strong performance in the sector in the second quarter as was observed in the first. Still, comments by survey respondents remained broadly positive, with some citing increased prices being passed on by suppliers and price pressures firming on commodities.

Although the U.S. manufacturing sector is still expanding, it will likely continue to face a number of challenges this year. Most important is the elevated level of policy uncertainty both globally and domestically, particularly concerning any upcoming changes to the U.S. trade pact with its NAFTA partners. Given U.S. manufacturers strong integration in global value chains, any material changes to U.S. trade policies could destabilize and do more harm than good as far as domestic industries are concerned in the short to medium term. A strong dollar should also continue to dampen the export competitiveness of U.S. firms, despite attempts by the new administration to talk down its strength.

Overall, the manufacturing sector is off to a good start thus far for 2017, and its strength and resilience highlights how anomalous the first release of first quarter GDP is. The good news is that this morning’s data on personal consumption expenditure suggests that consumer spending should see a lift in momentum at the start of the second quarter, albeit due to a rebound in utilities rather than the broad boost to spending that was hoped for. Still, both producer and consumer prices have lost momentum in recent months, which is likely to warrant some caution from the Federal Reserve, and if this persists it could make the path of interest rate normalization more gradual.

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