US factories are having too much of a good thing, with surging demand leading to system-wide bottlenecks that are weighing on business and potentially the broader economy.
The latest evidence came in the Institute for Supply Management’s April manufacturing survey, which showed that despite robust orders, production cooled as suppliers’ delivery times lengthened, backlogs mounted, materials prices picked up and hiring slowed.
Exacerbating the issues are policies including the Trump administration’s tariffs on imported metals, as well as new trucking regulations that have delayed deliveries.
Together, these forces could restrain manufacturing, which accounts for about 12 percent of the US economy, after solid job gains and global growth spurred a wave of optimism and filled order books over the past year.
The constraints — which threaten profit margins — may also blunt the effects of the $1.5 trillion tax cut for corporations and individuals, which was signed by President Donald Trump in December and was aimed partly at revving up factory investment even faster.
“Overall conditions are solid in the manufacturing sector right now — there’s no doubt about that. But all of this good news could be laying the foundation for a slowdown later on,” Societe Generale senior US economist Omair Sharif said. The added costs to companies for freight transportation and materials, along with higher tariffs, will contribute to a slowdown or even recession in late 2019, he said.
The ISM report showed its main manufacturing index fell to 57.3 in April, the lowest since July. That indicates expansion remains solid, though the pace is moderating.
The figures came on the heels of several regional Fed surveys over the past two weeks showing companies are paying more for materials and their optimism about future business has dimmed, amid the overhang of US tariffs and a potential trade war.
The Philadelphia Fed’s index of business activity in the coming six months dropped to the lowest level since July. A similar index for New York state slumped by the most since the terrorist attacks in September 2001. The Richmond Fed’s indexes showed orders and shipments shrank last month for the first time since 2016.
“The bigger picture globally is that manufacturing surveys have peaked in recent months, and we don’t expect to see new highs in the ISM in this cycle even if the trade war talk fizzles out completely,” Ian Shepherdson, chief economist at Pantheon Macroeconomics Ltd., wrote in a note. US factories are having some success passing along costs, according to the Fed surveys.
Still, the expansion in manufacturing remains broad-based, with 17 of 18 industries in the ISM survey reporting growth in April, including wood products and electrical equipment and appliances.
The question economists are increasingly grappling with is how long the good times can last.
“The market has to brace for the potential of a downside trend in a lot of this incoming data,” said Lindsey Piegza, chief economist at Stifel, Nicolaus & Co. “We really underestimated how much of the activity in 2017 was built on pure optimism, confidence, people feeling better.