Manufacturing Bottlenecks

Markit reports Prices Rise at Record Pace as services rebound.

Key Findings

• Flash U.S. Composite Output Index at 57.3 (55.0 in September). 3-month high.
• Flash U.S. Services Business Activity Index at 58.2 (54.9 in September). 3-month high.
• Flash U.S. Manufacturing PMI at 59.2 (60.7 in September). 7-month low. 
• Flash U.S. Manufacturing Output Index at 52.3 (55.7 in September). 15-month low.  

U.S. private sector businesses recorded a sharp and accelerated upturn in output led by the service sector during October, with growth the strongest for three months, albeit still much weaker than seen earlier in the year. However, October also saw a survey-record rise in backlogs of work as firms struggled to meet demand due to supply chain bottlenecks and labour shortages, in turn driving the steepest rise in prices yet recorded by the survey.  

Stronger sales placed further pressure on business capacity during October. The level of outstanding business rose at a series record pace, with respondents linking the latest rise with supply issues and a lack of staff. Subsequently, companies stepped up their hiring efforts in October.

Employment increased at the quickest pace since June in spite of further reports of difficulties sourcing candidates and retaining staff.

October data also highlighted stronger inflationary pressures across the US economy. Average input prices rose at a survey record pace, with firms attributing higher costs to supply issues, material shortages, greater transport fees and increased wage bills. Subsequently, the rate of selling price inflation for goods and services also hit a new series peak.

Supply issues and sustained sales growth prompted firms to further increase their buying activity and inventories.

The rate of increase in new orders eased to the slowest for eight months, but remained sharp overall. Survey respondents mentioned that order books were again buoyed by strong client demand. At the same time, material shortages, combined with logistical issues and greater commodity prices, were all linked to a further rise in average input costs in October. The rate of inflation surpassed August’s record to reach a fresh series high. Factory gate charges also rose at the fastest pace in the series history as firms continued to pass greater cost burdens through to clients.  

Chris Williamson Markit Chief Business Economist Comments

• “October saw resurgent service sector activity as COVID-19 case numbers continued to fall, marking a encouragingly strong start to the fourth quarter for the economy. Hiring has likewise picked up as firms have been encouraged to expand capacity to meet rising demand. 
• “However, while manufacturers also continue to report strong demand, factory production remains plagued by constraints, including record supply chain bottlenecks and labor shortages. Prices paid by factories for raw materials rose at yet another new record pace as a result, in turn feeding through to both higher prices at the factory gate and spilling over into higher service sector prices. Higher wages are also having to be offered to attract or retain staff, adding to the inflationary pressures. 
• “Thus, while the economy looks set for stronger growth in the fourth quarter, the upward rise in inflationary pressures also shows no signs of abating.”  

What About Inventories?

I highlighted most of the inflation references. But here's the potential key sentence.

"Supply issues and sustained sales growth prompted firms to further increase their buying activity and inventories."

Thanks to supply constraints, the rush is on to accumulate inventory. 

Meanwhile, actual growth estimates for the third quarter is falling rapidly.

Soft Patch in the Third Quarter or Does a Recession Start?

Note that manufacturing output is at 52.3, a 15-month low, with the expansion-contraction point at 50.

The Atlanta Fed GDP model for the third quarter is 0.5% growth. 

However, 2.1 percentage points of that rise are an inventory build. Since inventories net to zero over time, the real bottom-line estimate for the third quarter is -1.6%.

For discussion, please see Soft Patch in the Third Quarter or Does a Recession Start?

Two Key Questions

• To what extent is the attempt to increase inventory in the midst of a supply crunch itself contributing to huge price increases?
• Will demand accelerate in the fourth quarter to meet the inventory build?