March brought the strongest manufacturing growth in more than 37 years, and with it increasing indications about inflation pressures in the months ahead.
The Institute for Supply Management’s monthly manufacturing survey registered a 64.7% reading, representing the level of companies reporting expansion against contraction. That translated to a 3.9 percentage point increase from February, and the highest level since December 1983.
Moreover, responses to various subcategories within the readings, as well as the written summations from survey participants, showed how tight conditions are in the sector.
“Widespread supply chain issues. Suppliers are struggling to manage demand and capacity in the face of chronic logistics and labor issues. No end in sight,” wrote a respondent in the machinery field.
“Business bottomed out in February; we are expecting steady improvement through the end of the year. Inflation and material availability, along with logistics, are major concerns,” said another executive in the furniture and related products industry.
Their comments reflect subcomponents within the ISM survey.
While the prices paid component edged lower, it remained elevated at 85.6%. Backlogs registered 67.5%, while inventories tumbled further to just 29.9%, which the survey classifies as “too low.” Low levels of goods often translate into higher costs.
Survey respondents said “their companies and suppliers continue to struggle to meet increasing rates of demand due to coronavirus … impacts limiting availability of parts and materials,” ISM Chair Timothy Fiore said.
“Extended lead times, wide-scale shortages of critical basic materials, rising commodities prices and difficulties in transporting products are affecting all segments of the manufacturing economy,” he added.
Pressures may not be temporary
For many economists, the survey simply reinforced a message that other data points have shown lately, namely that inflationary pressures continue to build and perhaps not on simply a transitory basis as Federal Reserve officials have indicated.
The last time the ISM manufacturing reading was that high was just before a year when gross domestic product grew at a 7.2% pace and inflation was at 3.8%.
Supply chain issues, including but not limited to the bottleneck in the Suez Canal, along with trillions in cascading government stimulus and rising prices for real estate, food and gasoline all point to more inflation ahead.
“The bigger picture is that fiscal policy remains highly expansionary and is only one of several factors that point to a sustained rise in inflation,” Jonathan Peterson, an economist at Capital Economics, said in a note.
The Fed has been aggressive in its push for higher inflation, with officials repeatedly saying they want a level of at least 2% and are determined to keep interest rates low until that goal is achieved.
Chairman Jerome Powell has said he anticipates the next several months to show substantially higher readings, but attributes that to “base effects,” or comparisons to readings a year ago that were unusually subdued in the early days of the Covid-19 crisis.
However, that narrative is not universally shared by those seeing pressures building on a longer-term basis.
“While supply chain issues should eventually be resolved, in coming months we expect supply of inputs to remain a constraint on production and a source of upward pressure on prices,” Citigroup economist Andrew Hollenhorst wrote.
“Input prices are clearly rising across manufacturing sectors with most firms reporting higher prices paid for raw materials,” he added. “Some of this may be absorbed by firms compressing profit margins, but we expect some higher input costs to be passed through to consumer resulting in higher consumer goods inflation.”
Implications for the Fed
The supply chain issue in particular is vexing officials now.
The White House is weighing whether to conduct regular “stress tests” for key industries when it comes to supply chains, and even is considering stockpiling key materials and goods, according to reporting from CNBC’s Kayla Tausche.
Specifically, the administration is looking at four key supply chains: active pharmaceutical ingredients, critical minerals, high-capacity batteries and semiconductors, according to Tausche, who cited administration officials familiar with the issue.
Hollenhorst said he expects the Fed to watch data on prices and employment closely for how close the economy is to the central bank’s standards for full and inclusive employment as well as inflation around 2%. Fed officials have indicated they expect to keep short-term borrowing rates close to zero for several years, though they have backtracked before when the data contradicted their forecasts.
Recent data on labor and pricing “suggest rapid rehiring and prospects for higher inflation, at least in the manufactured goods sector, which should ultimately lead to ‘substantial further progress’ toward the Fed’s dual objectives,” Hollenhorst wrote.
The Fed is unlikely to act anytime soon to head off inflation, but markets have gotten impatient, with bond yields rising significantly this year on expectations of higher inflation and a rapid economic recovery.
Government stimulus has fueled large bursts in consumer spending, both in January and March. For the seven-day period ended March 27, credit and debit card spending was up 40% over a two-year period for people receiving stimulus payments, according to Bank of America.
“Bottom line, we know manufacturing has certainly been the source of economic strength but along with the headaches of delivering enough products cost effectively and on time,” said Peter Boockvar, chief investment officer at Bleakley Advisory Group. “The key to whether inflation is transitory or not will be in part dictated by how soon those headaches get resolved.”