Services Activity Continues to Outperform Manufacturing as Housing Receives Temporary Bump from Lower Rates in January

Key Takeaways:

• The ISM Manufacturing Index increased 0.3 points to 47.7 in February, breaking a streak of five consecutive monthly declines but remaining in contractionary territory. The new orders index rose 4.5 points to 47.0, its highest level since October 2022 but also still below the expansionary threshold of 50. The not-seasonally adjusted prices paid index jumped 6.8 points to 51.3, indicating input prices are increasing for the first time since September 2022. This doesn’t appear to be supply chain-related, though, as the supplier deliveries index declined 0.4 points to 45.2, indicating delivery timelines are continuing to shorten.
• The ISM Services Index declined one-tenth to 55.1 in February. The new orders index was up 2.2 points to 62.6, indicating continued strength ahead. The prices index was down 2.2 points to 65.6 while the supplier deliveries index declined 2.4 points to 47.6, its lowest level since 2009.
• Durable goods orders declined 4.5 percent in January after a 5.1 percent gain in December, though this was due almost entirely to volatility in commercial airline orders, according to the Census Bureau. Core capital goods orders (nondefense excluding aircraft) increased 0.7 percent, the largest gain since August 2022. Shipments of durable goods, a proxy for business fixed investment, declined 0.1 percent.
• Light vehicle sales declined 6.3 percent to a seasonally adjusted annualized rate of 15.2 million, giving back part of the 19.2 percent jump in January, according to Autodata.
• The Conference Board Consumer Confidence Index declined 3.1 points to 102.9 in February. Confidence in the present situation was up 1.7 points to 152.8, but this was more than offset by a 6.3-point drop in consumer expectations for the future, which at 69.7 hit their lowest level since July 2022.
• The National Association of REALTORS® Pending Home Sales Index, which records contract signings of existing homes and typically leads closing by one to two months, increased 8.1 percent to 82.5 in January, its highest level since August 2022.
• Private residential construction spending declined 0.6 percent in January, the eighth consecutive monthly decline, according to the Census Bureau. Expenditures on single-family structures declined 1.7 percent, while multifamily spending was up 0.4 percent. Spending on improvements increased 0.3 percent.
• The FHFA Purchase-Only House Price Index increased 6.6 percent compared to a year ago in December, a deceleration of 1.7 percentage points compared to November. On a seasonally adjusted basis, home prices declined 0.1 percent from November to December but were up 0.3 percent from 2022 Q3 to Q4.

Forecast Impact:

The ISM Manufacturing index continues to indicate that manufacturing activity is contracting, though the small improvement leaves it at a level that is still higher than would be suggestive of an immediate recession – the index was as low as 47.6 in 2016 and 48.0 in 2012 without one occurring. Still, we expect manufacturing activity will remain weak in the near- to medium-term as demand for goods continues to soften. In addition, the unexpected increase in the prices paid index adds to evidence elsewhere that goods deflation may slow or even reverse, more evidence pointing to a likely upgrade to our near-term inflation forecast. Further, with services activity remaining strong in February and the prices paid index remaining well above 60, near-term inflationary pressures from wages appear to remain well above normal. Still, we expect the light vehicle sales report to be the first of several that shows some give back in February after a strong January that was likely influenced by unusual seasonal factors.

The gain in the pending home sales index suggests there will be a corresponding increase in existing sales in February and perhaps some in March, though home sales are poised to soften further in 2023 as mortgage rates are back on the rise (6.65 percent, according to the latest Freddie Mac survey). Mortgage applications have pulled back sharply in recent weeks following rising mortgage rates.

Nathaniel Drake
Economic and Strategic Research Group
March 3, 2023

Opinions, analyses, estimates, forecasts, and other views of Fannie Mae's Economic and Strategic Research (ESR) Group included in these materials should not be construed as indicating Fannie Mae's business prospects or expected results, are based on a number of assumptions, and are subject to change without notice. How this information affects Fannie Mae will depend on many factors. Although the ESR group bases its opinions, analyses, estimates, forecasts, and other views on information it considers reliable, it does not guarantee that the information provided in these materials is accurate, current, or suitable for any particular purpose. Changes in the assumptions or the information underlying these views could produce materially different results. The analyses, opinions, estimates, forecasts, and other views published by the ESR group represent the views of that group as of the date indicated and do not necessarily represent the views of Fannie Mae or its management.