Manufacturing prices are crumbling...
Yesterday, the Institute for Supply Management ("ISM") released its manufacturing Purchasing Managers' Index ("PMI") for December. The numbers showed that business activity contracted more than expected during the month. Even more, this was the second consecutive monthly downturn, with the index hitting its lowest level since May 2020.
That last part is significant, as May 2020 was when the U.S. economy was just starting to emerge from COVID-19-related shutdowns. Activity had been at a standstill, so businesses were barely operating. In other words, the current state of business hasn’t been this bad since the pandemic brought the economy to a standstill.
We want to pay attention to the ISM manufacturing figures as they relate to the U.S. economy. The ISM sends questionnaires out to purchasing and supply managers at businesses across the country. It attempts to weigh the responses based on industry and their relevant contribution to domestic gross domestic product.
Respondents are asked a series of questions about current business activity compared with the month prior. The survey covers new orders, backlog of orders, new export orders, imports, production, supplier deliveries, inventories, customers' inventories, employment, and prices. The index total is based on whether conditions are better, worse, or the same compared with the previous month.
One of the key components we want to pay attention to is the prices paid by manufacturers for raw materials. That gives us a better idea of what it's costing them to produce goods. If that number is falling, it typically means demand is doing the same.
However, a lower cost to produce goods means companies can pass those savings on to customers, bringing down consumer prices as well. And as we can see in the chart below, the prices paid index also hit its lowest level since the pandemic...
Now, we want to look at the ISM's prices paid index relative to the U.S. Bureau of Labor Statistics' Producer Price Index ("PPI"). After all, they are measuring the same thing. So, when prices paid for raw materials are falling, the PPI should be doing the same...
As you can see, the prices paid index tends to lead the PPI. It peaked well before the BLS data, and it also dropped earlier. So, based on today’s data, we should see even more of a slowdown in inflation growth when the next round of manufacturing figures is released on January 18.
And if manufacturing prices continue to fall, it should support a change in monetary policy from the Federal Reserve. The central bank has been raising interest rates to bring inflation back to its 2% target. And while the current level of inflation growth isn't quite there, the data above tell us it's headed in that direction.