ISM factory index ticks down in August as price pressure continues to build

An employee of Independent Can Company works on the manufacturing line in Belcamp, Md.

Inflation is starting to frustrate U.S. manufacturers, and there are warning signs that price pressures will lead to slower activity in coming months after high readings this summer, according to the closely followed survey of manufacturers conducted by the Institute for Supply Management.

The headline ISM gauge of manufacturers sentiment, released Tuesday, dropped to 54.6% in August, from 55.6% in the prior month. That's the second-highest level in four years, and the eighth straight month that the index has been above the 50% threshold.

Still, experts say comments from manufacturers and the details of the report signal that trouble may be ahead for those companies - and overall U.S. growth.

"The economy is annoying, it is getting in the way of otherwise good business," said one unidentified manufacturer in the chemical sector, the biggest industry in the survey.

"We are making great new products but struggling to compete when prices escalate due to things like tariffs and the conflict in the Strait of Hormuz," the contact added, predicting that inflation will eventually lead to lower sales for the company.

"[The] manufacturing industry is expanding at a slower pace due to the chaotic impact of rolling tariffs and the Iran war on supply-chain conditions and prices," said Brian Bethune, an economist at Boston College.

Susan Spence, chair of the ISM manufacturing business survey, who authored the report, said in an interview that she's "starting to see warning signs" that customers are not spending money on orders.

Key indicators of demand - new orders, order backlogs and imports - saw large declines in the month, she noted. Positive sentiment for employment is also starting to erode.

Spence said she didn't have an answer for why demand was slowing, but noted many comments from manufacturers suggested it was due to higher prices.

"We had a few months where pricing volatility was calming down, and now it has stagnated," Spence said.

Tom Simons, chief U.S. economist at Jefferies, said the comments suggest that the manufacturing sector "is running fairly hot."

Fifteen out of 18 industries reported price increases. More than 20 commodities increased in price in August, while two declined.

"Inflation pressures are not abating, which explains why probabilities of a September interest-rate hike are rising," Jeffrey Roach, chief economist at LPL Financial, said of the likelihood that the Federal Reserve will raise interest rates in September in an effort to cool down price pressures.

One reason the Fed has a target of 2% inflation is because higher prices distort signals in the economy, making it harder for manufacturers to gauge demand.

Disrupted supply chains impact prices, but price "noise can then feedback to further disrupt supply chains and production, Bethune said.

Spence said conditions at the moment remind her of last year, when the manufacturing index sank below 50% for 10 straight months as "customers just stopped" buying due to uncertainty from tariffs.

In addition, the ISM survey was conducted before the Trump administration slapped new 50% tariffs on Canadian goods, which was followed by reciprocal tariffs on U.S. goods by Canada. The impact of that change will likely show up in next month's survey.

-Greg Robb