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US manufacturing shrinks for first time in 3 years

CNBC's Rick Santelli breaks down the data on the drop in the ISM Manufacturing Index, and what it indicates about the U.S. economy, with CNBC's Steve Liesman.

WASHINGTON — U.S. manufacturing shrank in June for the first time in nearly three years, a troubling sign as evidence builds that economic growth is slowing.

The Institute for Supply Management, a trade group of purchasing managers, said Monday that its index of manufacturing activity fell to 49.7. That's down from 53.5 in May and the lowest reading since July 2009, one month after the recession officially ended. Readings below 50 indicate contraction.

Production fell to a three-year low and a measure of new orders plummeted by the most in more than a decade, suggesting the weakness will likely persist in the coming months.

Stocks, which had largely been flat when the market opened, fell immediately after the report was released at 10 a.m. The Dow Jones industrial average dropped more than 70 points in morning trading.

"This is not good. Not good at all," said Dan Greenhaus, chief economic strategist at BTIG, an institutional brokerage. While the report "does not mean recession for the broader economy, it is still a terribly weak number."

Manufacturing, which has helped drive growth since the Great Recession ended, has begun to falter as the U.S. job market has fizzled and global growth has weakened.

Americans have pulled back on spending, which has lowered demand for factory-made goods. Europe's economy is likely in recession, which has hurt U.S. exports. And China's manufacturing sector grew in June at its slowest pace in seven months, according to a survey released Sunday by the state-affiliated China Federation of Logistics and Purchasing

The sharp drop in U.S. factory activity overshadowed more positive news on the housing market. U.S. construction spending rose for the second straight month, although spending remains well below healthy levels.

Manufacturing is likely to stay weak for the next few months. The ISM's gauge of new orders, a good measure of future activity, plunged from 60.1 to 47.8. That's the first time it has fallen below 50 since April 2009, when the economy was still in recession.

Fewer new orders reflect growing concerns of businesses. Many are worried about growth slowing from the anemic 1.9 percent annual pace in the January-March quarter. Europe's financial crisis and the prospect that U.S. lawmakers won't extend a package of tax cuts at the end of the year have added to the uncertain outlook.

Bricklin Dwyer, an economist at BNP Paribas, said the increasing uncertainty "has left businesses unwilling to invest."

A gauge of production also fell to its lowest level in more than three years.

U.S. factories are also reporting much less overseas demand, likely because Europe's financial crisis has lowered demand for U.S. exports. A measure of exports dropped to 47.5, its lowest level since April 2009.

A gauge of employment edged down but remained at a healthy level of 56.6. That suggests factories may still be adding jobs. Manufacturers have reported job gains for eight straight months.


Factories have been a key source of jobs and growth since the recession ended almost three years ago. But the sector has shown signs of weakness in recent months.

Manufacturers produced less in May than in April, the Federal Reserve said this month. Automakers cut back on output for the first time in six months. In June, manufacturing activity barely grew in the New York region and contracted sharply in the Philadelphia area, according to surveys by regional Federal Reserve banks. Factory output ticked up in Chicago but only after sliding for three months.

Consumers are less confident in the economy than they have been at any time all year, according to a measure of consumer sentiment released Friday. Worries about slowing job growth are outweighing the benefits of lower gas prices. A separate measure of consumer confidence, issued Tuesday, showed that confidence fell for the fourth straight month.

Overall hiring has slowed sharply this spring, raising concerns about the pace of the recovery. Employers added an average of only 73,000 jobs per month in April and May. That's much lower than the average of 226,000 added in the first three months of this year. The unemployment rate rose in May to 8.2 percent from 8.1 percent, the first increase in a year.

Slower job growth and falling confidence is weighing on consumers' willingness to spend. Americans cut back on purchases of autos and other long-lasting factory goods in May, the government said Friday.

U.S. exports of manufactured goods have also suffered as Europe's financial crisis has cut into demand in that region. And slowing growth in China, India and other emerging markets means that companies in Asia and Latin America are buying fewer American-made cranes, trucks and other heavy equipment.

There have been a few good signs recently.

U.S. factories received more orders for long-lasting manufactured goods in May, the government said last week, while also noting that a key measure of business investment plans rose.

And home sales are up from last year, with prices rising in most cities and homebuilders planning to break ground on more projects in the next 12 months. That should raise demand for manufactured goods such as appliances, building materials and furniture.

Still, the Federal Reserve has cut its forecast for the year. It now expects growth of just 1.9 percent to 2.4 percent for 2012. That's half a percentage point lower than the range it estimated in April. The Fed also says unemployment won't fall much further this year than it has.

The Associated Press contributed to this report.

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