Watch Now

Survey data shows slowing economy as tariffs loom

Photo: Jim Allen, FreightWaves

Survey data points to an economy that is slowing thus far in the third quarter. Manufacturing and service sector data continues to signal expansion in the overall economy, but values in each area have hit multi-year lows. 

Data from the Institute of Supply Management (ISM) showed that U.S. factory activity expanded at a slower pace in July, as the manufacturing Purchasing Manager’s Index (PMI) fell 0.5 points to 51.2 on a seasonally adjusted basis. This result is still above the expansionary threshold of 50, but is the fourth straight decline in the headline index and the lowest value for the manufacturing sector in nearly three years. Of the 18 responding industries in the manufacturing sector, half reported declines in July, indicating that there is still plenty of weakness in manufacturing in the economy.

Within the manufacturing data, sub-indices on both current production and employment weighted down overall results during the month, with the former also reaching multi-year lows. The new orders component, which gives an advance look at future production, ticked up to 50.8 in July after hitting the lowest value since the end of 2015 in June. Despite the improvement, new orders remain barely in expansionary territory and signal continued slow growth going forward.

In the service sector, results followed a similar pattern, with the ISM non-manufacturing headline index falling 1.4 points to 53.7 in July. Like the manufacturing sector, this marks the lowest value for the non-manufacturing index since the third quarter of 2016 and signals a positive, but subdued pace of growth in the service sector. Growth was a bit more broad-based on the non-manufacturing side of the economy, with 13 of 18 industries reporting a contraction. Notably, both wholesale trade and retail trade reported contraction, however, with implications for freight movements in the economy.

ISM data in the manufacturing and nonmanufacturing sectors point to slowing growth

Labor availability, tariffs taking a toll

Comments from ISM respondents suggest that tariffs are continuing to have an effect on overall economic  activity, particularly in the manufacturing sector. One respondent from the Computer & Electronic industry noted: “China tariffs continue to be a concern. The uncertainty of future tariffs involving China, Canada and Mexico is also a concern. China tariffs for electronic parts are averaging 17 percent.” A commenter from the Plastics and Rubber Products industry highlighted the harm caused by China’s retaliation, noting “All aspects of business remain strong, but we’re starting to see the frictional effect of tariffs on exports.” The tariff impacts were not limited to the manufacturing sector, however, with one respondent from the Information industry commenting: “Some uncertainty hinges on tariffs, but there have been no changes in market conditions.”

Tight labor conditions were also among the chief concerns facing producers in both sectors, continuing a trend that has been prevalent in survey data for the past couple of years as the unemployment rate has neared multi-decade lows. One respondent in the Retail Trade industry highlighted these concerns, stating, “As our corporate objectives drive us more and more into digitization, advanced analytics, and data management in general, we are finding it increasingly difficult to find, develop and retain professional with advanced skills in these disciplines.” A respondent in the Furniture & Related Products industry echoed these sentiments, noting: “Business is strong mostly due to seasonality. Tariffs surcharges are now being passed through to all customers. Labor is tight, putting pressure on wages costs.”

About the ISM Index

Each month, the Institute of Supply Management surveys purchasing managers in the manufacturing and service sectors on different aspects of business, asking whether or not their activity is expanding or contracting. Data is collected on things such as employment, production, prices, exports, inventories and orders. Responses are then weighted to create the ISM manufacturing and non-manufacturing indices.

Readings above 50 signal that more than half of the respondents to the survey believe that overall manufacturing activity is expanding during the month, while readings below 50 are a sign that activity is contracting. Historically, index results over 55 are a sign of above-trend growth in the manufacturing sector.

ISM data also gives some insight into trucking freight conditions. Manufacturing production is one of the key supports for freight demand in the economy, and readings from the ISM index typically are a leading indication on the amount of truck tonnage growth in trucking markets. 

Behind the Numbers

The survey data in the U.S. continues to point to an economy that has slowed considerably over the past couple of quarters. The manufacturing PMI readings haven’t tipped into contractionary territory, as they did in 2016, but have clearly decelerated and are consistent with a manufacturing sector that is experiencing essentially flat growth year-over-year. This has important implications for freight activity in the economy, as manufactured goods then get transported throughout the economy to the end customer.

From a broader macroeconomic perspective, the service sector reading are also a concern. Service industries make up approximately two-thirds of overall economic activity in the U.S. and are an even bigger proportion of employment growth in the economy. The employment subcomponents are still quite strong in the service sector data, but keep in mind that employment is typically a lagging indicator. Business activity and new orders on the non-manufacturing side of the economy have clearly shifted into a lower gear, and it may not be long before the attitudes towards hiring follows suit.

The recently announced tariffs on an additional $300 billion of goods imported from China is likely to make things worse. This next wave of tariffs are likely to hit the retail sector much harder than last year’s initial salvo. In tandem, the current readings from the ISM indices point to an economy that is growing at around a 2 percent pace or slower at the start of the third quarter. These tariffs are unlikely to throw the economy overall into a recession, but could take even more momentum out of an already slowing economy.

Ibrahiim Bayaan is FreightWaves’ Chief Economist. He writes regularly on all aspects of the economy and provides context with original research and analytics on freight market trends. Never miss his commentary by subscribing.