(Bloomberg) -- U.S. factories are having too much of a good thing, with surging demand leading to system-wide bottlenecks that are weighing on business and potentially the broader economy.
The latest evidence came Tuesday in the Institute for Supply Management’s April manufacturing survey, which showed that despite robust orders, production cooled as suppliers’ delivery times lengthened, backlogs mounted, materials prices picked up and hiring slowed. Exacerbating the issues are policies including the Trump administration’s tariffs on imported metals, as well as new trucking regulations that have delayed deliveries.
Together, these forces could restrain manufacturing, which accounts for about 12 percent of the U.S. economy, after solid job gains and global growth spurred a wave of optimism and filled order books over the past year. The constraints -- which threaten profit margins -- may also blunt the effects of the $1.5 trillion tax cut for corporations and individuals, which was signed by President Donald Trump in December and was aimed partly at revving up factory investment even faster.
“Overall conditions are solid in the manufacturing sector right now -- there’s no doubt about that. But all of this good news could be laying the foundation for a slowdown later on,” Societe Generale senior U.S. economist Omair Sharif said. The added costs to companies for freight transportation and materials, along with higher tariffs, will contribute to a slowdown or even recession in late 2019, he said.
Federal Reserve policy makers may be weighing the factory data as they conclude a two-day meeting in Washington on Wednesday. They’re expected to leave interest rates unchanged, then raise them at their next gathering in June for the second time this year, amid the lowest unemployment rate since 2000 and inflation in line with their target.
The ISM report on Tuesday showed its main manufacturing index fell to 57.3 in April, the lowest since July. That indicates expansion remains solid, though the pace is moderating.
The figures came on the heels of several regional Fed surveys over the past two weeks showing companies are paying more for materials and their optimism about future business has dimmed, amid the overhang of U.S. tariffs and a potential trade war.
The Philadelphia Fed’s index of business activity in the coming six months dropped to the lowest level since July. A similar index for New York state slumped by the most since the terrorist attacks in September 2001. The Richmond Fed’s indexes showed orders and shipments shrank last month for the first time since 2016.
“The bigger picture globally is that manufacturing surveys have peaked in recent months, and we don’t expect to see new highs in the ISM in this cycle even if the trade war talk fizzles out completely,” Ian Shepherdson, chief economist at Pantheon Macroeconomics Ltd., wrote in a note.
What Our Economists SayThe manufacturing ISM eased for a second month in April, having reached a near 14-year high in February. That still leaves the measure at an elevated level consistent with robust growth in the second quarter. Moreover, the new orders component remained at a particularly solid level despite a slight softening. That suggests that the headline reading may be overstating any cooling signals and that underlying economic activity continues to build momentum.
-- Niraj Shah and Carl Riccadonna, Bloomberg Economics
Read more for the full reaction note on the ISM factory index.
The more pressing issue is transportation. Companies face bottlenecks on America’s highways getting products from ports, warehouses and factories to their destinations. New safety rules requiring truckers to use electronic logging devices to record hours on the road, ensuring they don’t fudge their times on paper logs, are putting further upward pressure on costs in an already tight labor market.
The unpredictability of road conditions means that drivers are pulling over on the sides of highways or stopping early in the drive for fear of being penalized.
Many publicly traded U.S. companies highlighted the transportation-cost issue on their first-quarter earnings calls. Coca-Cola Co. executives said April 24 that the company faces “significant freight headwinds in North America” this year. Anixter International Inc., a distributor of wiring and communications products, said April 26 that freight costs boosted operating expenses and management is seeing double-digit increases in some freight prices.
U.S. factories are having some success passing along costs, according to the Fed surveys.
Still, the expansion in manufacturing remains broad-based, with 17 of 18 industries in the ISM survey reporting growth in April, including wood products and electrical equipment and appliances.
The question economists are increasingly grappling with is how long the good times can last.
“The market has to brace for the potential of a downside trend in a lot of this incoming data,” said Lindsey Piegza, chief economist at Stifel, Nicolaus & Co. “We really underestimated how much of the activity in 2017 was built on pure optimism, confidence, people feeling better. That only lasts for so long.”
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