U.S. factory activity hits two-year high as ISM PMI reaches 54

U.S. manufacturing expanded at the fastest pace since May 2022, with the ISM PMI rising to 54 in May and beating analyst expectations.

U.S. manufacturing expanded at the fastest pace in more than two years in May, with the Institute for Supply Management's purchasing managers index rising to 54, topping the 53.2 consensus estimate from economists polled by The Wall Street Journal. Readings above 50 indicate sectoral expansion, and May marked the fifth consecutive month of growth for the factory sector.

The ISM's new orders and production sub-indices both strengthened during the month, the survey showed. A separate gauge from S&P Global corroborated the trend, with its U.S. Manufacturing PMI coming in at 55.1 in May, down slightly from a preliminary estimate of 55.3 but still the highest reading since May 2022. The S&P survey pointed to the sharpest upturn in production since April, signaling that demand remains robust across the manufacturing base.

The data suggests the manufacturing sector is gaining momentum after a prolonged period of weakness, driven by robust domestic demand, inventory rebuilding, and ongoing reshoring efforts tied to the CHIPS Act and other industrial policy initiatives. However, the prices paid component of the ISM survey likely remained elevated — the S&P survey showed input costs rising sharply, with firms citing higher fuel, oil, metals and transportation prices. Suppliers' delivery times lengthened for a seventh consecutive month, adding to cost pressures that could squeeze margins for manufacturers unable to pass through higher expenses.

The stronger-than-expected reading complicates the Federal Reserve's policy calculus. With manufacturing activity accelerating and input cost pressures persisting, the case for near-term rate cuts weakens. Markets are now pricing a lower probability of a September rate reduction compared with before the data release, according to fed funds futures. The 10-year Treasury yield rose four basis points to 4.51 percent after the report as traders trimmed rate-cut bets, while the dollar index edged higher against major currencies. The S&P 500's industrial sector outperformed the broader index in early trading, with the Dow Jones Transportation Average also gaining as the data reinforced expectations of sustained economic growth.

The last time the ISM PMI exceeded 54 was in May 2022, when the index stood at 55.4 before embarking on a 17-month stretch below the 50 threshold that ended in January. That period coincided with the Fed's most aggressive tightening cycle in decades, as policymakers raised rates by 525 basis points from March 2022 to July 2023. The current expansion, by contrast, is unfolding against a backdrop of steady rates, with the fed funds rate held at 4.25 percent to 4.50 percent since the last cut in December. The question for markets is whether this manufacturing strength represents a sustainable recovery or a temporary boost from inventory restocking ahead of potential tariff increases.

The divergence between a strengthening factory sector and still-elevated price pressures creates a challenging backdrop for the Fed. While the goods side of the economy shows resilience, the central bank's preferred inflation measures — the core PCE deflator — have remained sticky above the 2 percent target. The next Fed decision on June 17-18 will be closely watched for any shift in the committee's assessment of economic momentum, particularly in the summary of economic projections and the dot plot of rate expectations.

Globally, the U.S. data stands in contrast to trends elsewhere. Japan's factory growth slowed in May as cost pressures surged, with the au Jibun Bank Japan Manufacturing PMI declining from the prior month. Turkey's manufacturing sector neared stabilization with its PMI rising to 49.8 — still in contraction territory but the highest since March 2024, as export orders returned to growth for the first time in 21 months. The divergence highlights the relative strength of the U.S. economy compared with other major manufacturing economies, a factor that has kept the dollar bid against most developed-market currencies and contributed to the widening of interest rate differentials in favor of dollar-denominated assets.

This article is for informational purposes only and does not constitute investment advice.