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Timothy Dunne

Timothy Dunne is a former vice president and economist of the Federal Reserve Bank of Cleveland.

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01.04.07

Economic Trends

ISM Report on Business Activity

Tim Dunne and Bethany Tinlin

According to the latest release of the Institute for Supply Management (ISM) surveys, both the manufacturing and nonmanufacturing sectors expanded as they closed out 2006. The ISM composite index for manufacturing registered a rebound in December, finishing out the year at a level of 51.4. The ISM uses a diffusion index, and a level above 50 indicates that the sector is expanding, while a value below 50 indicates contraction. The manufacturing index has trended downward over 2006, showing a general slowing in growth in manufacturing. As has been the case all year, the nonmanufacturing index has showed considerably more strength than manufacturing, closing out the year at 57.1—slightly down from November’s reading of 58.9.

ISM Manufactures and Services Diffusion Indexes

Source: Institute for Supply Management.

Looking at the details of the reports, the new orders and production components in manufacturing showed improvement in December compared to November, with both indexes moving from below 50 to above 50. For nonmanufacturing industries, new orders also continued to grow but at a slower rate than in November. The growth in new export orders slowed in manufacturing but accelerated for nonmanufacturers.

New Orders Index

Source: Institute for Supply Management.

Production Index

Source: Institute for Supply Management.

ISM Export Diffusion Indexes

a. Not seasonally adjusted.
b. Seasonally adjusted.
Source: Institute for Supply Management.

The employment picture differed across the two sectors as 2006 finished up. The manufacturing employment index remained slightly below 50 in December, indicating little change in employment in manufacturing. This index has hovered around 50 since September. Alternatively, the employment index for nonmanufacturing industries increased moderately in December to 53.3, suggesting continued expansion in nonmanufacturing payrolls.

ISM Employment Diffusion Indexes

Source: Institute for Supply Management.

The ISM also surveys producers on the prices they pay for supplies and services. For 2006, both manufacturers and nonmanufacturers reported a general slowing in the growth in prices over the year. However, the December surveys paint a mixed picture on the growth in prices at the end of the year. The manufacturing price index fell sharply to below 50, indicating decreasing supply prices. The manufacturing price index is now well below the average values observed earlier in 2006. In the nonmanufacturing sector, the index rebounded from the November reading to 59.1, showing some strengthening in supply prices in the last month of the year. Even with this increase, the nonmanufacturing index ended the year significantly less than its peak level in 2006 of 77.5 and well below the average index values in 2004 and 2005.

ISM Price Diffusion Indexes

Source: Institute for Supply Management.

Overall, the ISM surveys offer a picture of an economy that at the end of 2006 continues to grow moderately, with some evidence of a reduction in the price pressures observed earlier in the year.

What’s in store for 2007? Producers are relatively optimistic looking forward to 2007. The December ISM Semiannual Economic Forecast indicates that supply executives expect, on average, to increase production capacity by 5 percent to 6 percent in 2007. If this expected growth is achieved, it would represent an acceleration in capacity growth compared to 2006, when survey respondents reported increases in capacity of about 3 percent. Both sectors expect capital expenditures to increase in nominal terms by roughly 8 percent next year, and this is in line with the growth in capital expenditures observed in 2006. On the employment front, manufacturers see little expansion in payrolls while nonmanufactures forecast an increase of 1.6 percent.

The supply executives differ in their forecasts of supply price growth in 2007. Manufacturing supply executives think the price growth they saw in 2006 will abate and forecast supply prices to increase, on average, by only 1.1 percent in the upcoming year. Alternatively, nonmanufacturers see continued price pressures expecting supply price increases of 4 percent in 2007—a roughly 1.5 percentage point rise in expected supply price inflation compared to 2006.

ISM Forecasts for 2007

  Manufacturing forecast (percent) Nonmanufacturing forecast (percent)
Growth in production capacity
+5.4
+6.2
Growth in nominal capital expenditures
+8.5
+8.2
Employment growth
+0.1
+1.6
Growth in supply prices
+1.1
+4.0

Source: Institute of Supply Management.