By Lucia Mutikani
WASHINGTON(Reuters) - U.S. manufacturing pulled off a three-year low in April as new orders improved slightly and employment rebounded, but activity remained depressed amid higher borrowing costs and tighter credit, which have raised the risk of a recession this year.
Despite the weakness in factory activity and demand for goods reported by the Institute for Supply Management (ISM) on Monday, there was a build-up of inflation pressures last month.
This supports expectations that the U.S. Federal Reserve will raise interest rates by another 25 basis points to a 5%-5.25% range on Wednesday before potentially pausing its fastest monetary policy tightening campaign since the 1980s.
"The economy will likely slide into recession later this year," said Jeffrey Roach, chief economist at LPL Financial (NASDAQ:LPLA) in Charlotte, North Carolina.
"The persistent pricing pressure on manufacturers should abate in the coming months. Still, the Fed will likely hike rates this week and perhaps start telegraphing their likely decision to pause the rate-hiking campaign later this summer."
The ISM said its manufacturing PMI increased to 47.1 last month from 46.3 in March, which was the lowest reading since May 2020. Economists polled by Reuters had forecast 46.8.
It was the sixth straight month that the PMI remained below 50, which indicates contraction. And activity could remain subdued as the ISM noted that customers' inventory levels "are now at the low end of the 'too high' level," and "likely not conducive to future output growth."
Though a separate S&P Global (NYSE:SPGI) survey showed manufacturing expanding for the first time in six months in April, factories continued to report hesitancy among customers to place orders because of higher prices and economic uncertainty.
The ISM says a PMI reading below 48.7% over a period of time generally indicates the economy is in recession.
The ISM said 73% of manufacturing gross domestic product was contracting, up from 70% in March. But it noted that fewer industries declined sharply.
"The proportion of manufacturing GDP with a composite PMI calculation at or below 45 percent - a good barometer of overall manufacturing weakness - was 12 percent in April, compared to 25 percent in March," said Timothy Fiore, chair of the ISM Manufacturing Business Survey Committee.
Only two of the six biggest manufacturing industries, petroleum and coal products as well as transportation equipment, reported growth.
Stocks on Wall Street were trading higher, while the dollar gained against a basket of currencies and U.S. Treasury prices fell.
MIXED RESPONSES
In addition to the higher interest rates and tighter lending standards by banks following the recent financial market turmoil, manufacturing, which accounts for 11.3% of the economy, is also being dragged down by a shift in spending away from goods, typically bought on credit, to services.
Businesses are cutting back on restocking in anticipation of weaker demand later this year. The government reported last week that private inventory investment fell in the first quarter for the first time since the third quarter of 2021.
Business spending on equipment contracted for a second straight quarter, helping to restrain economic growth to a 1.1% annualized pace last quarter.
Responses from businesses in the ISM survey were varied.
Makers of computer and electronic products said after investing "heavily to de-risk the supply chain over the last three years due to COVID-19," they were "looking to reset with a number of our suppliers to reduce inventory."
Transportation equipment manufacturers viewed business as "steady," while makers of miscellaneous products said "conditions remain strong, with sales and bookings exceeding plan." Primary metals makers said "business is slowing, but in some ways, it isn't."
Food, beverage and tobacco products manufacturers reported that "after consecutive years of inflation and aggressive pricing to our retailers, we are starting to see resistance in the willingness to pass along pricing to end consumers."
The ISM survey's forward-looking new orders sub-index rose to 45.7 from 44.3 in March. Even though demand remained sluggish, inflation at the factory gate picked up. The survey's measure of prices paid by manufacturers rebounded to 53.2, the highest reading since last July, from 49.2 in March.
Prices increased despite the fastest supplier delivery performance since March 2009. Higher prices align with government data showing wages and salaries in the manufacturing industry growing solidly in the first quarter.
Though overall inflation is subsiding, underlying price pressures remain too strong to be consistent with the Fed's 2% target, much of it attributed to labor market tightness.
"Today's print for the prices paid index suggests the disinflationary impulse from goods remains frustratingly slow," said Tim Quinlan, a senior economist at Wells Fargo (NYSE:WFC) in Charlotte, North Carolina. "That could complicate the Fed's efforts to get inflation in check."
The survey's gauge of factory employment rebounded to 50.2 last month from 46.9 in March. Turnover rates fell to the lowest level since mid-2021, when the ISM started tracking the series.