Midwest Manufacturing Falls Into Contraction

Business activity across the Midwest declined in May after improving in recent months, reflecting waning demand and lingering headwinds facing many U.S. firms. 

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The Chicago Business Barometer, known as the Chicago PMI, slipped to 49.3 in May from 50.4 in April. In March, the index jumped back into positive territory to 53.3, the highest in about a year. 

Economists surveyed by The Wall Street Journal expected a more modest decline to 49.8. 

The Chicago report is the latest in the batch of monthly regional surveys looked to by economists and traders ahead of the Institute for Supply Management's national manufacturing report due out Wednesday. The Chicago survey is slightly different in that it includes some firms from the much bigger and better-faring service sector, and it is known to be a volatile measure. 

Surveys from most pockets of the country have been softer this month, following broad improvement in March that was largely sustained in April. The cooling in factory activity reflects ongoing headwinds that, while less intense lately, still remain: exporters are grappling with weaker demand abroad and with the strong dollar's negative effect on pricing, and manufacturers exposed to the energy sector are dealing with the continuing fallout of slashed spending budgets. 

Still, many economists say the worst is over for the long-suffering factory sector, even if more robust remains elusive. 

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Lower production pulled the Chicago index lower in May as new orders fell back below the 50 mark and to the lowest level since December. 

Firms' inventory levels, meanwhile, tumbled 12 points to 37.9. That marked the seventh straight month of contraction -- and the worst result since the end of 2009 -- reflecting uncertainty about future business growth. In response to a related special question, more than two-thirds of survey respondents said they didn't plan to increase business investment over the next six months. 

"Firms ran down stocks at the fastest pace for more than 6 years in May, and while a rebuilding over the coming months could support output, the underlying message appears to be that businesses are not confident about the outlook for growth," said Philip Uglow, chief economist at MNI Indicators, the compiler of the report. 

The underlying tone of the report was weak, said TD Securities deputy chief U.S. macro strategist Millan Mulraine. While the report is generally quite volatile, he said, "the broad-based weakening across most components causes us to highlight the downside risks" for Wednesday's ISM report. Mr. Mulraine expects the ISM to register at 50.2, down from 50.5 and matching the average forecast of analysts polled by the Journal. 

Write to Lisa Beilfuss at lisa.beilfuss@wsj.com