U.S. manufacturing activity surged to its strongest level in more than four years during July, but persistent price increases are forcing Federal Reserve officials to consider raising interest rates as early as next month.
The Institute for Supply Manufacturing reported a reading of 55.6 for July, the fastest pace of growth since May 2022 and above Wall Street's expectations of 54.0. The index measures the percentage of companies reporting expansion, with any reading above 50 indicating growth.
Production and Employment Gains
Strong gains in new export orders and backlogs drove the expansion, with production spiking 6.3 points. The employment gauge reached its highest level since August 2022 and marked an expansion for the first time in 33 months, according to ISM officials.
But the positive headline numbers masked troubling undercurrents. The prices index dropped only slightly to 71.1, meaning nearly three-quarters of all respondents reported rising prices for the 22nd consecutive month. That's a clear signal inflation isn't backing down.
Worse Than Pandemic Era
Purchasing managers described an environment more volatile than the COVID-19 disruptions. An executive in the primary metals sector said, "No normalcy in sight in the world of metals. It makes me yearn for the coronavirus pandemic chaos, which was more manageable than whatever this is that we are in."
A manager in the electrical equipment, appliances and components industry warned that "the pricing volatility and lead-time extensions in this market are arguably worse than the pandemic era." During COVID-19, the manager explained, "we saw a surge of price hikes and inventory buy-ups, which caused constraints that eventually leveled out." Now, "we are seeing nothing but consistent upward trends for both pricing and lead times that show no signs of slowing down."
The ISM survey lists respondents by industry but doesn't name them.
Fed Pressure Builds
The manufacturing dynamic presents a challenge to Federal Reserve Chairman Kevin Warsh and his colleagues. Several analysts said the combination of solid economic growth and ongoing price pressures strengthens the case for an interest rate increase soon, possibly as early as September.
That's a sharp reversal from eleven months ago, when officials expressed substantial worry over flat hiring and launched three consecutive rate cuts starting in September. The Federal Open Market Committee held its key overnight interest rate in a range between 3.5%-3.75% last week, where it's been all year.
Jeffrey Roach, chief economist at LPL Financial, wrote, "If trade is less of a drag this quarter and businesses restock inventories, economic growth could reach 2.2% in the third quarter. As a result of demand-induced inflation and energy supply shortages, the Warsh-led Fed will be pressured to raise rates on September 16."
Troy Ludtka, senior U.S. economist at SMBC Nikko Securities Americas, noted the production index hit its highest level since November 2021. He wrote, "Strong payroll growth from two of the most interest rate sensitive sectors [manufacturing and construction] will enable the Fed to continue its hawkish communication drift."
Goldman Sachs now tracks third-quarter economic growth at 2.4%, up from an initial estimate of 1.5% for the second quarter.
Traders remained somewhat skeptical despite the data. Odds for an increase at the Sept. 15-16 FOMC meeting stood at 64.5% midday Monday, down slightly from Friday, according to the CME Group's FedWatch tool. That followed comments from Warsh that many market participants viewed as ambiguous regarding the Fed's intentions.
Richard de Chazal, macro analyst at William Blair, wrote, "Companies continue to complain about the pricing environment, and this report shows that this is not changing much. From the Fed's perspective today's [ISM] report should help tilt the scales further toward tightening policy at the September FOMC meeting."
Inflation data for June showed some improvement as a brief pause in Middle East tensions drove down energy prices and shelter costs continued to moderate. However, virtually all pricing gauges show inflation still well above the Fed's 2% target.
Why This Matters:
The manufacturing sector's strength demonstrates the resilience of American enterprise, but the persistent inflation signals reveal the real cost of years of loose monetary policy and ongoing geopolitical instability. Businesses aren't just managing higher prices—they're navigating an environment that experienced managers now describe as worse than the pandemic chaos. That's not a temporary blip. The Fed's credibility depends on bringing inflation back to its 2% target, and these numbers show how far that goal remains. If the central bank delays action while price pressures build, it risks letting inflation expectations become unanchored, which would require even more aggressive rate increases later. The manufacturing data gives the Fed room to act without worrying about crushing a fragile economy. Markets are pricing in a September hike for good reason.