U.S. manufacturing activity sprang back to life in January, ending 26 months of contraction (nine months in the previous data series) as inventories had fallen to levels that triggered a steady increase in new orders on export and capital goods demand and pulled factory output out of the doldrums, the latest monthly data from the Institute for Supply Management showed.

Despite the growing uncertainties ahead of a trade war that has just erupted between Washington and Ottawa, the sector index compiled by the Institute for Supply Management popped above the make-or-break line of 50, rising a more than expected 1.7 points to 50.9 in January after edging closer to growth territory at 49.2 in December from 48.4 (recent figures have been revised in an annual update on seasonal adjustments). The index easily beat the consensus call of 49.5.

"Demand and production improved; and employment expanded," Timothy Fiore, chair of the ISM Manufacturing Business Survey Committee, said in a statement."However, staff reductions continued with many companies, but at weaker rates." Fiore had predicted that the ISM headline index would rise above 50 in the first quarter, in January or February, on signs of a pickup toward the end of 2024.

"Prices growth was moderate, indicating that further growth will put additional pressure on prices," he said."As predicted, maintaining a slower rate of price increases as demand returns will be a major challenge for 2025."

Fiore told reporters that the Trump tariffs would not help U.S. manufacturing firms because"it doesn't make sense" to pay duties on their own goods produced at factories in Canada and Mexico. In the face of high uncertainty over the new administration's trade policy,"I think you just have to grit your teeth here for the rest of the week to see what happens," Fiore said.

President Donald Trump launched a trade war by signing executive orders on Saturday to impose 25% tariffs on Canadian and Mexican imports to the U.S. and an additional 10% on China over illegal immigration and drug trafficking for which he blames those countries. Canadian Prime Minister Justin Trudeau has retaliated with similar 25% duties on U.S. goods while Trump on Monday delayed his 25% tariff on imports from Mexico for a month as his counterpart Claudia Sheinbaum agreed to deploy 10,000 additional troops to the border.

Asked if the U.S. manufacturing sector has seen a revival of demand without the help of further interest rate cuts by the Federal Reserve, Fiore replied that the sector is having a cyclical rebound after the long doldrums, adding that the Trump tariffs will probably support more rate cuts from the Fed, which has been cautious amid resilient economic growth and sticky services inflation. A few industries are performing well, led by chemical producers, Fiore said, but he also warned that there is"significant price growth there."

Among the five subindexes that directly factor into the manufacturing PMI, four were in positive territory: the new orders index at 55.1 (+3.0 points), production 52.5 (+2.6), employment 50.3 (+4.9), supplier deliveries 50.9 (+0.8) and manufacturing inventories 45.9 (-2.5). Among others, the prices paid index at 54.9 (+2.4) indicated raw materials prices increased for the fourth straight month while the new export orders index at 52.4 (+2.4) showed possible rush shipments to China before Beijing could slap any retaliatory duties on goods from the U.S.

Manufacturing remains in the doldrums with expectations for marginal contraction at 49.5 in January versus 49.3 in December and 48.4 in November.

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.