US Factory Activity Contracted in August

US manufacturing sector contracts for first time in 3 years

The Institute for Supply Management's manufacturing index decreased to 49.1 in August from 51.2 in July - with readings below 50 indicating contraction.

US manufacturers also cut jobs, the survey found.

President Donald Trump said on Tuesday trade talks with China were going well, but he warned that he would be "tougher" if the discussions dragged on past the 2020 USA election and he won a second term. Similar surveys in Europe and Asia showed earlier that factory activity had hit the skids.

The report confirmed that USA manufacturing has joined the global trend of sluggishness and contraction. Economists polled by Reuters had forecast the ISM index would slip to 51.0 in August. A reading below 50 generally signals a contraction in the economy. A stronger dollar makes USA exports more expensive for consumers whose income is paid in a foreign currency.

Investors were dismayed by the news. The Dow Jones Industrial Average plunged 285.26 points, or 1.1%, to 26,118.02. A measure of production declined by 1.3 points. Factories also cut jobs for the first time since September 2016. "This is the first sub-50 reading (the expansion/contraction boundary) since August 2016 and is the weakest figure since January 2016", said ING analysts.

But "another couple of months of declines on this scale would leave the USA facing an entirely unnecessary and self-inflicted recession", he wrote.

Yet that is not a foregone conclusion.

While the index indicates a contraction in manufacturing, at 49.1 it is not necessarily an indicator of a contraction in the broader economy.

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A sharp drop in oil prices in 2015 and lower prices for many agricultural products caused oil drillers and farmers to cut back the following year on their investment in tractors, machinery and drilling rigs. Stocks extended declines and the yield on 10-year Treasuries fell sharply Tuesday after the data was released.

Technology companies, which are especially sensitive to tariffs and shifts in China trade, dropped also. Construction spending fell 2.7% on a year-on-year basis in July. That implies that there are more USA manufacturers that plan on laying off workers than hiring them. Factory hiring is holding up better, so far. Last year, automobile manufacturing companies experienced one of the worst festival season sales in last five years, in the aftermath of the bankruptcy of IL&FS and the lack of liquidity in the banking system.

President Trump's fight with China, and his tariffs on steel and aluminum imports, are meant to help US manufacturers but are now having the opposite effect. Beijing then slapped tariffs of 5% in retaliation on $75 billion worth of American goods, such as US crude oil exports. China responded by charging tariffs of 10% and 5% on a list of American goods.

"Tariffs are still weighing heavily on supply managers' minds as they adjust their supply or manufacturing sources", Fiore said.

Andrew Hunter, senior USA economist at Capital Economics, said in a note that the weak ISM survey suggested that a combination of weak global demand and escalating trade tensions is taking an increasing toll on US producers. Manufacturing activity is declining in 17 out of 30 countries surveyed by the consulting firm IHS Markit.

Still, the ISM index remains above the 43 level, which economists associate with a recession.

On top of customer inventories being too low, the ISM showed that prices were decreasing while both exports and imports were contracting. Meanwhile, manufacturing activity declined across Japan, Taiwan, and South Korea.

The institute's new order measure dropped to a seven-year low, suggesting tariffs are dampening demand for new products from USA producers.

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