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ISM Index Fall Suggests U.S. Faces Another Soft Patch

Manufacturers' production and demand growth cooled last month, possibly signaling another spring economic slowdown, as federal budget tightening takes hold.

The Institute for Supply Management's factory activity index pointed Monday to slower expansion, dropping to 51.3 from 54.2 in February and missing forecasts for a shallower dip. Most components weakened, though job growth improved to a nine-month high.

U.S. stock indexes fell on the report, which overshadowed a rebound in construction outlays as well as data out Friday that pointed to strong consumer spending. Homebuilders Lennar (LEN), KB Home (KBH) and D.R. Horton (DHI) fell.

A separate manufacturing gauge was revised lower, but Markit said March still ended the best quarter in two years.

Higher payroll taxes in January and the across-the-board "sequester" cuts that kicked in March 1 are expected to cool the economy in Q2. The latest ISM data could be an early sign.

"The slowdown in growth momentum is consistent with uncertainty from the sequester," said Millan Mulraine, TD Securities' U.S. rates strategy director.

But the difference between a soft patch this spring from prior years is that the economy is on stronger footing, with the housing market and Americans' wealth recovering, he said.

ISM's production gauge tumbled to 52.2 from a 10-month high of 57.6, and orders sank to 51.4 from a 22-month high of 57.8. The weaker demand plus a sharp drop in backlogs suggest the pickup in hiring isn't sustainable, Mulraine noted.

Job growth has averaged about 200,000 in the last five months. Economists expect Friday's payrolls report to show a gain of 193,000. But any cooling could convince the Federal Reserve to maintain its bond buying program for longer.

Homebuilding could prop up manufacturing through the next few months. Industries like wood products and furniture were the top performers in March.

"Business is continuing to be brisk," one furniture firm's purchasing manager told ISM.

Construction spending rebounded a better-than-expected 1.2% in February after January's 2.1% retreat. Private residential outlays rose 2.2%, ending three straight months of declines.

Single-family homes leapt 4.3%, the most since August 2009, while multifamily spending slipped 2.2% for the first decrease in nearly 1-1/2 years.

Private nonresidential building grew 0.4%, a mild uptick from the prior month's 5.9% plunge. Public construction rose 0.9%, the best in six months.