Manufacturing activity grew at its fastest pace in four years this June due to a pickup in domestic demand and increased operational efficiencies.
The latest flash reading of the manufacturing purchasing managers’ index (PMI) maintained by Markit, an industry research firm, shows the index up 1.1 points, at 57.5, in June. The flash U.S manufacturing PMI, which is based on a monthly survey of select companies, represents about 85 percent of total respondents. The PMI is based on five indicators: new orders, inventories, production, supplier deliveries, and employment. A PMI reading of more than 50 indicates expansion, while a reading below 50 indicates contraction.
The headline numbers reflect rapid growth in manufacturing output and growth in new business orders. Manufacturing output is up for the third straight month, and the index is at its highest level in four years at 61 in June, up from 59.6 in May.
The increase is likely due to improved client confidence and a better overall economic outlook. According to Federal Reserve projections, the economy will grow in the range of 2.1 to 2.3 percent this year. Part of the improved outlook has to do with a low base effect, since the economy contracted by 1 percentage point in the first quarter this year due to a bad and prolonged winter, but as activity picked up in the second quarter, a strong pipeline of backlogged work helped bolster output.
From a broader perspective, another tailwind could be that firms in the U.S. have finally been able to employ technology and technology-enabled services as a way to cut costs and compete with low-cost competition from emerging economies in the sector.
Growth in new orders has been particularly impressive. The new orders index was up at 61.7 in June from 58.8 in May as domestic demand for manufactured goods gained momentum. According to the flash PMI survey, the average pace of expansion in the second quarter was the steepest for any quarter since early 2007. The cost of input index for manufacturers rose to 57 in June from 56.4 in May, signaling good domestic demand. Prices could have only risen due to demand, since the cost of credit has not changed much over the last four years.
The only letdown among the manufacturing indicators is the contraction in new export orders. The index for new export orders shrank to 50.9 in June from 52.2 in May. Global demand for U.S. manufactured goods has remained lukewarm since countries in Europe and Asia have flooded the markets with cheaper substitutes to meet global demand, aided by demographic advantages like cheaper labor costs and availability of natural resources.
To the relief of the Federal Reserve, which has repeatedly said that it is looking at the labor market conditions before making a move on increasing the federal funds rate, the employment picture in the manufacturing sector has started to look up. Employment numbers at manufacturing firms increased for the 12th consecutive month in June, with the index climbing to 53.8 from 53.7 last month.
The performance of the manufacturing sector in the second quarter has helped keep hopes alive of clocking a 3 percent growth in gross domestic product in the second quarter, even if the contribution of the sector to the overall GDP is relatively small. Manufacturing accounted for about 12.4 percent of economic value add in 2013, according to the BEA, but about 21 percent of economic growth.