Fed’s rate moves put manufacturing sector at risk
Factory demand slows as a result of higher interest rates and strong dollar
The American manufacturing sector is starting to show signs of weakness after two years of strong growth, as higher interest rates and a slowdown in exports threaten production.
New orders for manufactured goods contracted for the sixth straight month through February, according to surveys by the Institute for Supply Management. Manufacturing output is down 1.7% from its postpandemic peak in May 2022, according to a three-month moving average of Federal Reserve data. And the Commerce Department’s measure of civilian capital equipment orders, excluding aircraft—the building blocks of business—was down 3.4% in January from its recent high in November 2021, after adjusting for inflation.
Weaker manufacturing data suggests that consumers and businesses are starting to retrench in the face of economic uncertainty, said Jonathan Millar, senior U.S. economist at Barclays PLC. A manufacturing downturn could be a sign of trouble in the broader U.S. economy. Although manufacturing accounts for a relatively small share of gross domestic product, about 11%, it has historically been an early indicator of recession.
The Fed’s aggressive pace of interest-rate increases to fight inflation has made it more expensive to borrow for big-ticket items such as consumer appliances or business machinery. Fed officials in early February approved raising their benchmark rate to the highest level since 2007, and have signaled they are likely to raise rates again when they convene later this month.
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"As the Fed continues to hike, manufacturing is going to be in the crosshairs," Mr. Millar said. "It’s hard to see this sector not suffer some sort of a downturn that is more significant than what we’ve seen already."
The Fed could raise interest rates higher than previously anticipated this year to cool inflation, which recently showed signs of firming. "We cannot risk a revival of inflation," Fed governor Christopher Waller said last week.
Fed Chair Jerome Powell will discuss monetary policy when he appears before Congress on Tuesday and Wednesday. His testimony, along with reports this week on global trade, job openings and payrolls, will offer more clues about the direction of the economy in 2023.
The combination of elevated inflation and high interest rates has made some consumers think twice about buying big-ticket items such as appliances and power tools.
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"A lot of us that were home during Covid decided we were going to redo a bathroom or kitchen so there was a huge spike of demand," said Corbin Walburger, interim chief financial officer at toolmaker Stanley Black and Decker Inc., at a conference last month. Now "people are feeling a little bit of a pinch in their pocket books or, as we all know, have shifted some of their spending from hardgoods to services."
Some sectors of manufacturing are experiencing a sharp pullback.
Production of appliances, furniture and carpeting was down almost 15% in January from the previous year, according to the Fed. That coincides with sales of previously owned homes falling for 12 straight months. Consumers often buy furnishings after they move.
Production of steel, iron and other primary metals was down 3.6% and machinery production fell by 1.8%. Output of plastics, food, beverage and tobacco products, and computers and electronics, also fell during that period.
Employment in manufacturing is growing, and exceeds prepandemic levels, but job gains for the past three months through January eased to the slowest pace in a year and a half at a time when overall hiring firmed.
Manufacturing data can be choppy month-to-month and swing on demand for expensive aircraft, which can take years to deliver. More broadly, the manufacturing figures stand in contrast to other parts of the economy, which show surprisingly strong hiring, especially by service providers, still solid consumer spending on dining and travel, and rising incomes.
For now, it isn’t clear that the recent loss of momentum in manufacturing augurs a widespread downturn, though many economists expect the economy to cool this year as a result of the Fed’s actions.
"Reading the economic tea leaves suggests we’re going to see some weakness midyear," said Ryan Sweet, chief U.S. economist at Oxford Economics. "We might need a little luck to avoid a recession."
Some American factories have yet to feel the full effect of the drop-off in demand, largely because they are still working through backlogs of orders built up over 2021 and 2022 when supply-chain disruptions kept them from meeting customer demand.
Car and light-truck production hasn’t fully recovered to 2019 levels, running in January at a pace to build about a million fewer vehicles this year than the year before the pandemic began, according to Fed data. Fourth-quarter earnings at Ford Motor Co. were down 89% over the previous year, largely because supply-chain problems made it hard to get enough chips, executives said.
Business inventories swelled in the fourth quarter of last year, when consumer spending cooled. The ratio of inventories to sales for durable goods was higher in November and December than at any point since 2009, with the exception of April and May 2020, when pandemic-related lockdowns froze commerce.
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Pat Weiler, chief executive of paving-equipment maker Weiler, said inventory levels are up more than 50% over the last two years.
"That’s going to come back down once we can get some flow going again," he said. "That’s going to have an effect on our sub-suppliers."
The recently strong U.S. dollar has also made American exports more expensive abroad. New export orders have been contracting for seven straight months, according to ISM data. U.S. exports of goods declined for four straight months at the end of last year, the Commerce Department said.
Customer orders at Keysight Technologies Inc., a maker of testing equipment for technology companies, were down 13% in the latest quarter from the previous year, said Chief Executive Satish Dhanasekaran on a Feb. 21 conference call with analysts. He pointed to the strong dollar and geopolitical tensions with Russia and China.
"We saw customers exercise caution in response to macroeconomic uncertainty," he said.
Higher interest rates have also prompted some construction companies to put off buying new machinery.
Rod Schrader, the chief executive of equipment maker Komatsu America Corp., said demand from construction companies will decline around 11% this year while he expects a big increase in sales to rental providers who need to refill their fleets.
"It’s about a 3% decline in demand, coming off a record year of demand in 2022," he said.
One bright spot for U.S. manufacturers has been the aerospace sector. Orders from airlines have surged, as carriers are eager to rebuild their fleets and capitalize on people’s renewed willingness to travel. Orders of nondefense aircraft and parts have trended higher the past two years and now exceed prepandemic levels.
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"We’re involved in more big orders now than we’ve been in a long time," said Boeing Co. Chief Executive David Calhoun during a January conference call with analysts.