Manufacturing activity declined noticeably in March, owing to a drop in new orders, a slowdown in production, and a shift in consumer spending back towards services over goods. On Monday, the next edition of the Institute of Supply Management’s Purchasing Managers’ Index (PMI) is expected to show a sector continuing to struggle against multiple headwinds.

The PMI, a monthly report that survey’s manufacturers’ sentiments about the state of the sector, declined in March to 46.3 in March  from 47.7 in February. This was the lowest reading recorded since April 2020 when the COVID-19 pandemic grinds the U.S. economy to a halt. A reading below 50 indicates a fall in manufacturing activity. 

Here are five things to watch out for in the next report:

Manufacturing is likely to stay weak

According to economists’ surveyed by Bloomberg, the ISM report is expected to show a reading of 46.8, a slight uptick from where activity stood in March. 

“I think if you look at where you were in March, the expectation is a little less weak, but still weak,” said Kevin Cummings, the chief economist for Natwest Markets.  

Other regional manufacturing surveys, including those from the Federal Reserve branches in New York and Philadelphia, showed improvements in new orders and shipments. However, none of these reports suggest that the broader outlook for manufacturing is likely to improve. 

Manufacturing will keep falling behind services 

The U.S. economy relies heavily on consumer spending on services. This was disrupted by the pandemic, but the service sector’s rebound has come at the expense of strength in manufacturing. This is evident through the continued hiring of service workers in recent employment reports from the Labor Department, and the ISM’s separate report on services that shows activity here is still growing. 

“If you think about the economy more broadly, I think the services signal is more important than manufacturing,” said Oscar Munoz, a U.S. macro strategist at TD Securities. “It’s not to downplay manufacturing. But it’s been generally contracting for quite a bit.”

Employment can weaken further

In previous releases, the ISM suggested that employers were reluctant to let go of workers. Amid a tight labor market and a higher cost for labor, they were keen to hold on to the workforces they had now to meet their needs.

But this mood has been changing as manufacturers expect economic conditions to worsen. In February, the ISM sub-index for labor entered contraction territory with a reading of 49.1, but it soon fell to 46.9 by March. It is likely that the April report will still show a greater willingness on the part of manufacturers to part ways with their workers.

New orders and exports can still slide lower

The manufacturing sector is sensitive to changes in the wider global economy. After the reopening of China in January, the ISM sub-indexes for new exports and orders rose noticeably with the fresh demand that followed. A better-than-expected performance in European economies also provided a lift once fears of an energy crunch related to the war in Ukraine failed to spark a steep contraction. 

However, this trend did not last through February. It is unlikely to rebound again, owing to higher interest rates and the continued strength of the U.S. dollar relative to other currencies.

Less hopes for a more positive second half of 2023

Managers surveyed by the ISM in recent surveys bemoaned the decline in activity, but expressed optimism that the sector would see a better half of the year. 

With the recent bank failures in March and the Federal Reserve likely to continue raising interest rates to tame inflation, this optimism has waned. With fears of a coming credit crunch and a recession over the horizon, these hopes for a rebound may evaporate further. 

“It seems that the credit crunch is inevitable," said Cummings from Natwest Markets. "If the consumer starts to pull back, and the economy tips into recession, confidence amongst manufacturing leaders will probably get weaker than stronger."