Manufacturing sector posts first decline in nearly 3 years, while labor demand remains robust

04 Jan 2023 Manufacturing sector posts first decline in nearly 3 years, while labor demand remains robust

Authored by RSM US LLP, January 04, 2023

Industry and government data on Wednesday continued to paint a mixed picture of the economy as the end of the business cycle is approaching. The manufacturing sector showed its first monthly contraction following 30 straight months of growth, highlighting the impact of restrictive monetary conditions that the Federal Reserve continued to impose on the sector to fight inflation.

The Institute of Supply Management’s manufacturing index fell to 48.4, lower than the threshold of 48.7, which indicates overall long-term contraction.

Even as the Federal Reserve has succeeded in tamping down goods inflation—resulting in less manufacturing activity—the central bank has not been able to achieve its other goal of reducing demand for workers.

Job openings in the manufacturing sector—a proxy for labor demand—inched down only slightly in November to 10.46 million from 10.51 million in the prior month. Openings have been above 10 million since June 2021.

As labor supply shows no significant signs of improvement, strong demand will continue to put pressure on the imbalance in the job market, adding more fuel for wages to increase further.

While the manufacturing goods sector was expected to stay in contraction territory for quite some time, we have now entered the second leg of the inflation flight; inflation is concentrated in the service sector instead of the goods sector.

The Fed is also watching the labor market and the service sector closely, as the main concern in inflation’s second leg focuses on whether a strong labor market will create wage-push pressure on service inflation. Labor costs account for most of the increases in service prices.

So far, there is no clear sign of wage-push inflation. It will stay that way only if the Fed remains steady on its rate hike course to bring interest rates to a restrictive enough level—between 5% and 5.25%.

Underneath the top-line numbers, goods inflation continued to fall sharply, according to the Institute of Supply Management report. The prices paid index for output goods contracted in December, falling to 39.4 from 43 in the previous month. Employment within the sector surprisingly increased, inching to 51.4 after a month of decline in October.

A separate report from the Bureau of Labor Statistics showed that the quit rate in the month inched up to 2.7% from 2.6%. Hiring fell to 3.9% as many companies began to revise their hiring plans. Still, the hiring rate continued to stay at a pre-pandemic high.

This article was written by Tuan Nguyen and originally appeared on 2023-01-04. Reprinted with permission from RSM US LLP.
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