The latest economic data, which included two useful leading indicators, factory orders and construction pending, points to a softening economy. Leading indicators like these are particularly important because they are forward-looking and can provide advanced warning of changes in economic activity.
These two new economic releases could be foretelling a gradual economic slowdown is underway, which of course would have significant implications for future growth, monetary policy, and the financial markets.
Factory Orders Decline
Manufacturing activity continued to slow in May, marking the second consecutive month of decline. The Institute for Supply Management’s (ISM) manufacturing purchasing managers index fell to 48.7 from April’s 49.2, indicating contraction as it remained below the critical 50 level.
New orders dropped significantly, posting the largest decline since June 2022, falling by 3.7 points to 45.4, a one-year low. “Softening” demand reflects higher borrowing costs and reduced business investment.
Construction Spending Slips
Construction spending also showed unexpected weakness in April, declining by 0.1% following a 0.2% drop in March. This flew in the face of economists’ expectations of a 0.2% increase. The report revealed the decrease was caused by declines in non-residential construction, particularly commercial projects.
Public construction spending also fell, with both educational and highway construction seeing reductions. However, single-family residential construction edged up by 0.1%, reaching its highest level since August 2022. The increase was driven by limited existing home inventory, despite significantly higher mortgage rates.
Economic Growth Outlook
The combined impact of falling factory orders and construction spending points to a sluggish start for the second quarter. The first quarter saw GDP growth at a modest 1.3%, and recent data has led to downward revisions in growth forecasts.
The Atlanta Fed’s GDP Now model, which had been tracking above 2%, was revised down to 1.8% after these reports. Persistently high interest rates, maintained by the Federal Reserve to combat inflation, are dampening spending on manufactured goods and capital projects, contributing to the softer economic trend.
Inflation and Interest Rates
Despite the slowdown, inflation remains a concern. ISM data indicated that while factory input costs have eased from their peak, they are still quite high. This is due to rising commodity and freight costs. This scenario could complicate the Federal Reserve’s goal of returning inflation to its 2% target, and may further delay interest rate cuts.
Currently, interest rate futures suggest a 60% probability that the Fed will lower rates in September. Overnight lending rates remain in the 5.25% to 5.50% range.
Employment Trends
On the employment front, the factory sector showed some resilience. Factory employment increased for the first time since last September, with data expected to show 5,000 new manufacturing jobs in May. Overall, the labor market remains robust, with an anticipated 185,000 jobs added last month.
Bright Spots in Construction
While overall construction spending fell, there were some positive developments. Spending on factory construction rose by 0.9%, reaching a record high, driven by investments in domestic production of computer chips and green energy products under the Biden administration.
These are “Made in America” investments that aim to strengthen domestic manufacturing capabilities and reduce reliance on foreign supply chains.
Key Takeaway
The latest economic data on factory orders and construction spending indicate a softer economic trend, with significant implications for future growth and monetary policy. The declines in these leading indicators suggest that the economy is experiencing a gradual slowdown, posing challenges for inflation management and interest rate adjustments.
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