U.S. Economy: Manufacturing Shrinks Most Since 2003 (Update3)

By Courtney Schlisserman


Jan. 2 (Bloomberg) -- Manufacturing in the U.S. shrank the most last month in almost five years, triggering speculation that the Federal Reserve will cut interest rates by half a percentage point to stave off a recession.

The Institute for Supply Management's factory index fell to 47.7, from 50.8 the prior month, the Tempe, Arizona-based group said today. The figure was lower than forecast by any economist surveyed by Bloomberg News. Fifty is the dividing line between contraction and expansion.

Stocks fell and Treasury notes climbed as the report suggested the housing-market rout is spreading to the broader economy. The ISM's gauge has now fallen six straight months, the longest losing streak since the eve of the economy's last contraction in 2001.

``Right now we're not expecting a recession, but after this report we may have to revisit that forecast,'' said Kenneth Kim, an economist at Stone & McCarthy Research Associates in Skillman, New Jersey, which had the closest estimate in the Bloomberg survey. ``There's probably more pain and contraction to come'' in manufacturing, he said.

Traders increased bets the Fed will cut its benchmark rate when policy makers meet Jan. 29-30. The chance of a half-point reduction to 3.75 percent rose to 26 percent, from zero, according to futures quoted on the Chicago Board of Trade. Ten- year Treasury yields fell to 3.91 percent at 4:05 p.m. in New York from 4.02 percent late Dec. 31.

Economists' Estimates

Economists predicted the index would fall to 50.5, according to the median of 69 forecasts in a Bloomberg News survey. The manufacturing gauge, which covers about 12 percent of the economy, averaged 52.2 last year, down from 53.9 in 2006. The December reading was the first below 50 since January 2007.

The ISM's measure starts pointing to a recession across the economy when it falls below 41.9 for two straight quarters, according to Norbert Ore, chairman of the institute's manufacturing survey.

``I don't see sufficient evidence yet to have grave concern about recession following this,'' Ore said in an interview. ``I would want to see what January and February look like'' before drawing a conclusion.

A report from the Commerce Department showed spending on construction projects unexpectedly rose in November as work on schools, power plants and factories helped overcome cutbacks in homebuilding. The 0.1 percent increase followed a 0.4 percent drop the prior month that was smaller than previously reported.

Rising Prices

The group's index of prices paid rose to 68 from 67.5. Economists surveyed by Bloomberg had expected the measure to fall to 65.

The decrease in today's overall manufacturing index reflected a decline in new orders to the lowest level since October 2001. ISM's new orders index fell to 45.7 from 52.6. The production measure fell to 47.3 from 51.9.

The report follows others that show manufacturing weakening. The Philadelphia Federal Reserve's business gauge for December contracted for the first time in a year and the Richmond Fed's measure also was negative.

Orders for durable goods excluding transport equipment fell 0.7 percent in November, held back by a drop in defense procurement and machinery demand, the Commerce Department said on Dec. 27. Inventories of such goods unexpectedly rose and economists said they will remain watchful as to whether that will detract from economic growth later on.

The inventory index in today's report declined to 45.5 from 46.9. Figures less than 50 mean manufacturers are reducing stockpiles.

Inventories

Stockpile building added 0.89 percentage point to third- quarter economic growth and helped boost growth to the fastest rate in four years. Slower consumer spending and continued housing weakness the last three months of the year probably brought down economic growth in the quarter to a 1 percent pace, one-fifth the rate it did from July through September, according to a Bloomberg News survey taken last month.

The ISM's gauge of export orders fell to 52.5, from 58.5.

Increased exports had helped shield some companies from the effects of slowing U.S. demand last year. Some economists, including Michael Gregory at BMO Capital Markets in Toronto, expect that to change as growth in foreign countries slows.

``I think the last few months you've had a change in attitudes in a lot of major markets outside the U.S.,'' Gregory said.

Turning Overseas

Even so, some companies are shifting more attention to overseas sales. Eaton Corp., the world's second-largest maker of hydraulic equipment, announced plans Dec. 20 to buy Moeller Group of Germany and Phoenixtec Power Co. of Taiwan.

``We are seeing the U.S. economy slowing,'' said Alexander M. Cutler, chief executive officer at Eaton Corp., in a Dec. 21 interview. There is the ``potential that industrial production could move to flat to slightly negative in the first quarter.''

Some companies are trimming their spending. FedEx Corp., the second-biggest U.S. package-delivery company, lowered its capital spending forecast for the full year by 11 percent, to $3.1 billion, and said additional reductions are ``possible'' as executives review the timing of spending plans.

``We see challenging near-term economic trends,'' Chief Executive Officer Fred Smith said in a statement Dec. 20.

Illinois Tool Works Inc., the maker of Duo-Fast nail guns and Wilsonart countertops, last month cut its full-year earnings forecast, in part because of lower-than-expected sales in North America. Also Black & Decker said that retailers placed fewer orders last quarter because consumers are buying fewer tools for home remodeling projects as the housing slump enters its third year.

Less Hiring

Some companies are preparing for a slowdown by cutting back on hiring or trimming their payrolls.

The ISM's employment measure rose to 48 from 47.8 in November, which was the lowest in four years.

The government is scheduled to release the December employment report on Jan. 4. The number of Americans who continued to collect unemployment benefits, considered by some economists to be a harbinger of companies' willingness to hire, rose to a two-year high in the week ended Dec. 15, the Labor Department said on Dec. 27.