An operator stacks a heavy steel strut used for an industrial workbench leg at Tennsco’s facility in Dickson, Tennessee, United States, on February 17, 2021.

Tennsco | via Reuters

March brought the strongest growth in manufacturing in more than 37 years, increasing signs of inflationary pressures in the months ahead.

The Institute for Supply Manufacturing’s monthly survey found a score of 64.7%, which is the level of companies reporting expansion versus contraction. This corresponds to an increase of 3.9 percentage points compared to February and the highest level since December 1983.

In addition, the responses to various sub-categories within the readings as well as the written summaries of the survey participants showed how tense the conditions are in the industry.

“Widespread problems in the supply chain. Suppliers have problems managing demand and capacity in the face of chronic logistics and labor problems. There is no end in sight,” wrote one respondent in the machinery space.

“Business bottomed out in February. We expect steady improvement through the end of the year. Inflation and material availability as well as logistics are major concerns,” said another manager in the furniture and allied product industry.

Your comments reflect sub-components within the ISM survey.

While the price component was lower, it remained higher at 85.6%. Orders on hand were at 67.5%, while inventories continued to decline to just 29.9%, which the survey rates as “too low”. Small quantities of goods often lead to higher costs.

Respondents said “their companies and suppliers continue to struggle to meet increasing coronavirus demand … impacting limited availability of parts and materials,” said ISM Chairman Timothy Fiore.

“Extended lead times, widespread bottlenecks in critical raw materials, rising raw material prices and difficulties in transporting products affect all segments of the manufacturing industry,” he added.

The pressure cannot be temporary

For many economists, the survey has only reiterated a message that other data points have shown recently, namely that inflationary pressures will continue to rise, and possibly not just temporarily, as Federal Reserve officials have pointed out.

The last time ISM manufacturing value was this high was just a year ago, when gross domestic product grew 7.2% and inflation was 3.8%.

Supply chain problems, including but not limited to the Suez Canal bottleneck, as well as trillions of cascading government incentives and rising prices for real estate, food and gasoline point to further inflation.

“The big picture is that fiscal policy is still very expansionary and is just one of several factors pointing to sustained spikes in inflation,” said Jonathan Peterson, an economist at Capital Economics, in a note.

The Fed aggressively pushed for higher inflation. Officials repeatedly said they wanted levels of at least 2% and are determined to keep interest rates low until that target is met.

Chairman Jerome Powell said he anticipates the next few months will see much higher readings, but attributes this to “baseline effects” or comparisons with readings a year ago, which were unusually subdued in the early days of the Covid-19 crisis were.

However, this narrative is not widely shared by those who see pressures build up over the longer term.

“While supply chain problems should be resolved at some point, we expect the supply of supplies to remain a drag on production and a source of upward pressure on prices for the coming months,” wrote Citigroup economist Andrew Hollenhorst.

“Input prices are increasing significantly in all manufacturing sectors, with most companies reporting higher raw material prices,” he added. “Some of that may be absorbed by companies compressing their profit margins, but we expect higher input costs to be passed on to consumers, leading to higher inflation in consumer goods.”

Effects on the Fed

The problem of the supply chain in particular is now annoying officials.

The White House is considering conducting regular “stress tests” on key industries in relation to supply chains, and is even considering storing critical materials and goods, according to reports from CNBC’s Kayla Tausche.

In particular, the administration deals with four major supply chains: active pharmaceutical ingredients, critical minerals, high-capacity batteries and semiconductors, according to Tausche, the administrative official familiar with the problem quoted.

Hollenhorst said he expects the Fed to monitor prices and employment data closely to see how close the economy is to the central bank’s standards for full and inclusive employment, as well as inflation of around 2%. Fed officials have said they expect short-term lending rates to stay close to zero for several years, although they previously pulled back when the data contradicted their forecasts.

Recent labor and price data “suggests rapid recruitment and prospects for higher inflation, at least in the capital goods sector, which should ultimately lead to” significant further progress “in achieving the Fed’s dual goals,” wrote Hollenhorst.

The Fed is unlikely to act to counter inflation anytime soon, but markets have grown impatient. Bond yields have risen significantly this year on expectations of higher inflation and a rapid economic recovery.

Government incentives spurred consumer spending up sharply in both January and March. In the seven-day period ending March 27, credit and debit card spending increased 40% over a two-year period for those receiving stimulus payments, according to Bank of America.

“The bottom line is that manufacturing has certainly been the source of economic strength, but along with the headache of getting enough product cheaply and on time,” said Peter Boockvar, chief investment officer at Bleakley Advisory Group. “The key to whether or not inflation is temporary will depend in part on how quickly these headaches are resolved.”