US manufacturing activity was in contraction for a fourth straight month in July on continued weak demand as firms remain reluctant to invest in capacity amid elevated borrowing costs and they are laying off employees to tide over what appears to be a protracted trough, the latest monthly data from the Institute for Supply Management released showed.

The sector index compiled by the ISM, which indicates general direction, plunged 1.7 percentage points to an eight-month low of 46.8, the 20th contraction in the past 21 months, after dipping 0.2 point to 48.5 in June. The latest reading came in far below the median economist forecast of 48.8.

Timothy Fiore, chair of the ISM Manufacturing Business Survey Committee, told reporters that even if the Federal Reserve lowers its policy interest rate in September, as widely expected, new orders are unlikely to pick up for several months, although a shift to credit easing should help lift sentiment. Fiore said he believes the manufacturing sector is stuck in a temporary trough, instead of diving into a new phase of contraction.

Firms also remain concerned about supply chain disruptions amid heightened geopolitical risks, the ISM survey showed. The uncertainty over the results of the US election in November is also keeping manufacturers uneasy about the future US energy policy as to whether it will seek greener energy sources or rely heavily on oil and gas, Fiore said.

"Demand remains subdued, as companies show an unwillingness to invest in capital and inventory due to current federal monetary policy and other conditions," Fiore said in a statement."Production execution was down compared to June, likely adding to revenue declines, putting additional pressure on profitability. Suppliers continue to have capacity, with lead times improving and shortages not as severe."

The new orders index contracted in July for the fourth consecutive month, registering 47.4, a decrease of 1.9 percentage points compared to June's figure of 49.3. It hasn't indicated consistent growth since a 24-month streak of expansion ended in May 2022."Panelists' comments noted a continued level of uncertainty and concern about a lack of new order activity, with confidence in the future economic environment reaching its lowest level since the coronavirus pandemic recovery," said Fiore.

The employment index registered 43.4 in July, down 5.9 points from 49.3 in June and hitting its lowest level since a reading of 42 in June 2020."The index contracted for the second consecutive month after an expansion in May, which broke a seven-month streak of contraction," Fiore said. Respondents' companies are continuing to reduce head counts through layoffs, attrition and hiring freezes. Panelists' comments in July indicated a notable increase in staff reductions compared to June, supported by the approximately 1-to-1.8 ratio of hiring versus head-count reduction comments, Fiore said.

The prices paid index stood at 52.9, 0.8 percentage point higher compared to the June reading of 52.1, indicating raw materials prices increased in July for the seventh month after eight consecutive months of decreases."Commodity prices continue to be volatile, especially oil, natural gas, aluminum and plastic resins. Steel prices have reached long-term historical lows, supported by declining scrap prices," Fiore said. Twenty-three percent of companies reported higher prices in July, compared to 20 percent in June.

After edging 2 tenths lower in June to 48.5, the ISM manufacturing index, which has missed Econoday's consensus the last three reports in a row, is expected to edge higher to a still subpar 48.8 in July.

The manufacturing composite index from the Institute for Supply Management is a diffusion index calculated from five of the eleven sub-components of a monthly survey of purchasing managers at roughly 300 manufacturing firms nationwide. The survey queries purchasing managers about the general direction (tracked in volumes) of production, new orders, order backlogs, their own inventories, customer inventories, employment, supplier deliveries, exports, and imports. Data on changes in input prices (prices paid) are also tracked. The five components of the composite index are new orders, production, employment, supplier deliveries, and inventories (their own, not customer inventories). The five components are equally weighted. The questions are qualitative rather than quantitative; that is, they ask about the general direction rather than the specific level of activity. Each question is adjusted into a diffusion index which is calculated by adding the percentage of positive responses to one-half of the unchanged responses.

Investors need to keep their fingers on the pulse of the economy because it dictates how various types of investments will perform. By tracking economic data such as the ISM manufacturing index, investors will know what the economic backdrop is for the various markets. The stock market likes to see healthy economic growth because that translates to higher corporate profits. The bond market prefers less rapid growth and is extremely sensitive to whether the economy is growing too quickly and causing potential inflationary pressures.

The ISM manufacturing data give a detailed look at the manufacturing sector, how busy it is and where things are headed. Since the manufacturing sector is a major source of cyclical variability in the economy, this report has a big influence on the markets. More than one of the ISM sub-indexes provide insight on commodity prices and clues regarding the potential for developing inflation. The Federal Reserve keeps a close watch on this report which helps it to determine the direction of interest rates when inflation signals are flashing in these data. As a result, the bond market is highly sensitive to this report.

Importance
The ISM manufacturing composite index indicates overall factory sector trends. The relevance of this indicator is enhanced by the fact that it is available very early in the month and is not subject to revision.

Interpretation
The bond market will rally (fall) when the ISM manufacturing index is weaker (stronger) than expected. Equity markets prefer lower interest rates and could rally with the bond market. However, a healthy manufacturing sector, indicated by rising ISM index levels, bodes well for corporate earnings and is bullish for the stock market.

The level of the ISM manufacturing index indicates whether manufacturing and the overall economy are growing or declining. Historically, readings of 50 percent or above are associated with an expanding manufacturing sector and healthy GDP growth overall. Readings below 50 indicate a contracting manufacturing sector but overall GDP growth is still positive until the ISM index falls below 42.5 (based on statistics through January 2011). Readings in between these two levels suggest that manufacturing is declining while GDP is still growing but only very slowly.

In addition to the ISM manufacturing composite index, the various sub-components contain useful information about manufacturing activity. The production component is related to industrial production, new orders to durable goods orders, employment to factory payrolls, prices to producer prices, export orders to merchandise trade exports and import orders to merchandise imports.

Vendor (supplier) deliveries are an important component of report. The more slowly orders are filled and delivered, the stronger the economic growth and the greater the potential for inflation. When orders are filled quickly, it means that producers don't have as many to fill.

The ISM manufacturing composite index and its sub-components can be subject to some monthly volatility, making the three-month average of the monthly levels more indicative of the trend.