U.S. Manufacturing Output Unexpectedly Weak In May

Production at U.S. factories unexpectedly fell in May, the latest sign of cooling economic activity as the Federal Reserve aggressively tightens monetary policy to tame inflation.

The first decline in manufacturing output since January reported by the Fed on Friday followed news this week of a drop in retail sales last month as well as steep declines in homebuilding and permits. The weakness in production also reflects a shift in spending from goods to services.

"It adds to the evidence that the economy is slowing," said Andrew Hunter, a senior U.S. economist at Capital Economics. "But there is still little in activity data to suggest a recession is on the horizon, or to dissuade the Fed from pressing ahead with more aggressive policy tightening."

Manufacturing output dipped 0.1% last month after increasing 0.8 in April. Economists polled by Reuters had forecast factory production gaining 0.3%. Output rose 4.8% compared to May 2021.

Manufacturing, which accounts for 12% of the U.S. economy, has been supported by strong demand for goods. But spending is gradually reverting back to services, while Russia's dragging war against Ukraine and China's zero-tolerance COVID-19 policy have further entangled supply chains.

A strong dollar as a result of rising interest rates could make U.S. exports more expensive. The U.S. central bank has hiked its policy interest rate by 150 basis points since March.

"Manufacturing activity is likely to face near term headwinds from supply chain dislocations from the war in Ukraine and COVID policy in China," said Rubeela Farooqi, chief U.S. economist at High Frequency Economics in White Plains, New York.

A survey from the New York Fed this week showed activity at factories in New York state remained soft in June, with unfilled orders falling for the first time in over a year. Weaker conditions were also reported in the mid-Atlantic region, with the Philadelphia Fed's measure of manufacturing activity posting a negative reading this month for the first time since May 2020.

May's surprise decline in factory production followed three months growth averaging nearly 1%. Nondurable manufacturing production edged up 0.1%, supported by increases in petroleum and coal products, which offset declines in food, beverage and tobacco products as well as paper and printing.

But the output of long-lasting goods fell 0.2%, pulled down by declines in wood products and machinery. Production at auto plants rose 0.7% last month after advancing 3.3% in April.

Mining production increased 1.3% after rising 1.1% in the prior month. Utilities output climbed 1.0% after surging 5.5% in April. The solid gains in mining and utilities offset the dip in manufacturing, lifting overall industrial production 0.2%. Industrial output jumped 1.4% in April.

Capacity utilization for the manufacturing sector, a measure of how fully firms are using their resources, edged down 0.1 percentage point to 79.1% in May. It is 1.0 percentage points above its long-run average. Overall capacity use for the industrial sector rose to 79.0% last month from 78.9% in April. It is 0.5 percentage points below its 1972-2021 average.

Officials at the Fed tend to look at capacity use measures for signals of how much "slack" remains in the economy - how far growth has room to run before it becomes inflationary.