The economy's waning fortunes have been blamed on the White House's year-long trade war with China. President Donald Trump said on Tuesday trade talks with China were going well, but he warned that he would be "tougher" in negotiations if the discussions dragged on past the 2020 US election and he won a second term. "The canary in the mine may be falling off its perch," said Joel Naroff, chief economist at Naroff Economic Advisors in Holland, Pennsylvania. "With manufacturing now starting to contract, it is even more critical that the consumer keeps spending."
The Institute for Supply Management (ISM) said its index of national factory activity dropped to a reading of 49.1 last month from 51.2 in July. A reading below 50 indicates contraction in the manufacturing sector, which accounts for about 12% of the US economy. Last month marked the first time since August 2016 that the index broke below the 50 threshold.
August's reading was also the lowest since January 2016 and was the fifth straight monthly decline in the index. The United States now joins the euro zone, Japan, the United Kingdom and China, which have long been experiencing a contraction in factory activity. Still, the ISM index remains above the 43 level, which economists associate with a recession. The US-China trade tensions also coincide with diminishing stimulus from last year's $1.5 trillion tax cut package.
The ISM said there had been "a notable decrease in business confidence," adding that "trade remains the most significant issue, indicated by the strong contraction in new export orders." Economists polled by Reuters had forecast the ISM index would slip to 51.0 in August. With trade tensions simmering in the background, the Federal Reserve is expected to cut interest rates again this month to keep the economic expansion, now in its 11th year, on track.
The Fed lowered its short-term interest rate by 25 basis points in July for the first time since 2008, citing trade tensions and slowing global growth. Financial markets have fully priced in another quarter-percentage-point cut at the Fed's September 17-18 policy meeting.
The ISM's forward-looking new orders sub-index dropped to a reading of 47.2 last month, the lowest level since June 2012, from 50.8 in July. A measure of export orders plunged 4.8 points to the lowest level since April 2009. The survey's factory employment tumbled to 47.4, the weakest reading since March 2016, from 51.7 in July. This raises the risk that factory payrolls contracted in August. Manufacturers cut hours in July, pushing the factory workweek to its lowest level since November 2011. Factories also cut overtime in July.
In a separate report on Tuesday, the Commerce Department said construction spending edged up 0.1% in July. Data for June was revised up to show construction outlays decreasing 0.7 instead of falling 1.3% as previously reported.
Economists polled by Reuters had forecast construction spending would rise 0.3% in July. Construction spending fell 2.7% on a year-on-year basis in July.