IEZ - September Industrial Production: Too Strong

2023-10-17 13:13:33 ET

Summary

• U.S. Industrial Production growth in September accelerated relative to August and exceeded forecasters' expectations.
• Overall Industrial Production growth has accelerated in the past 3 months, contrary to what the U.S. Fed would like to see.
• The U.S. economy is running "too hot."  As a result, a "higher-for-longer" interest rate environment is increasingly likely.  This significantly raises the risk of a major economic slowdown and/or recession.

The Industrial Production and Capacity Utilization Report , corresponding to activity during the month of September 2023, was published by the U.S. Federal Reserve on October 17, 2023, at 9:15 AM. This report is widely considered to provide some of the best indicators of the production of goods in the U.S. economy, available at a monthly frequency.

In this article, we will walk our readers through an in-depth analysis of the data in the Industrial Production and Capacity Utilization Report, and then proceed to discuss potential implications for the U.S. economy and financial markets.

Summary Data and Analysis

We begin our analysis of the Industrial Production and Capacity Utilization report by reviewing summary information in Figure 1.

Figure 1: Change, Acceleration, Expectations, and Surprise

Total Industrial Production grew by 0.29%, which ranks in the 54th percentile. This represents an acceleration of 0.26% compared to last month’s growth of 0.03% (revised down from 0.38%). The reported growth in September was an upside surprise compared to the median forecast of 0.10%. The manufacturing component of industrial production grew by 0.20%, compared to -0.09% the previous month. This was greater than the consensus forecast of 0.10%.

We will now proceed to our detailed analysis of the Industrial Production data.

Analysis of Growth Rates By Component Categories

Industrial Production data can be broken down in three different ways: by Industry Group, Market Group, and by Stages. In Figure 2 we take these breakdowns and display their annualized growth rates and respective historical percentile ranks over various time frames (1m, 3m, 6m and 12m). The objective of this analysis is to compare the growth rates of different components and to compare growth rates across different time frames.

Figure 2: Annualized Growth Rates of Key Components

Industry Breakdown

Market Breakdown

Stage Breakdown

A key trend to notice is that overall Industrial Production growth has accelerated from well-below-historical-average growth (25th percentile) over the past 12 months to significantly-above-average growth in the past 3 months (74th percentile). However, it should, at the same time, be noted that growth in the more economically-sensitive sectors of the economy has only accelerated to rates that are near their historical averages.

Decomposition Analysis: Contributions To Change And Acceleration

In Figure 3, we perform a decomposition analysis of the MoM growth in Industrial Production, according to the three different ways of breaking down the data.

Figure 3: Contributions of Components to Change and Acceleration

Industry Breakdown

Market Breakdown

Stage Breakdown

Manufacturing accounted for most of the change in Industrial Production for this month. Both Durable and Nondurable Manufacturing were strong contributors to the acceleration in Industrial Production. In terms of negative contributors, Electric Utilities was the only industry component to decelerate in September. In the Market breakdown, Materials ex. energy provided a disproportionate positive contribution to both change and acceleration while Energy was the largest negative contributor to acceleration.

Implications For The Economy

The Industrial Production report for September indicates that the U.S. economy may be running “too hot,” as far as the U.S. Fed and interest rate markets are concerned. This overall impression is strongly reinforced by US Retail Sales data that was published earlier today that indicated above-average strength in consumer spending (which significantly exceeded expectations).

The Fed would like to see Industrial Production growing at a below-average pace rather than an above-average pace. This report indicates the opposite, with U.S. Industrial Production having accelerated in the recent 3-month period to a well-above-average pace. A further potential source of concern is the fact that during the past month, the most economically sensitive components of Industrial Production grew at a pace that was even faster than the overall average.

Implications for Financial Markets

In our article on Retail Sales earlier today, we highlighted the fact that the U.S. economy is growing at a pace that is uncomfortably “hot” for the U.S. Fed, and for financial markets as a whole. As a result, expectations among financial markets participants will be heightened that the interest rate environment in the U.S. will be one of “higher for longer.”

“Higher for longer,” implies challenging conditions for U.S. financial markets in the intermediate term. The tightness of financial conditions, including relatively high interest rates, will tend to place downward pressure on the pricing of both U.S. bonds and the U.S. equities, in the intermediate term.

In the shorter term, we think that bond and equity markets may still have some room to recover from recently oversold technical conditions.

Conclusion

It is our view that the U.S. economy will not be able to tolerate the current level of interest rates for much longer before business activity in various sectors starts to become stressed and the rate of growth in the overall economy starts to slow down severely. Indeed, our view is that the risk of recession in the U.S. economy is rising very quickly.

Investors should consider taking decisive actions to limit risk in their portfolios that is tied to a potential downturn in the U.S. business cycle. In our own portfolios at Successful Portfolio Strategy, we have been taking a series of actions aimed at capitalizing on anticipated intermediate-term weakness in equity markets and a significant turn-around in bond markets, particularly in terms of the real interest rate component of long-term U.S. Treasury yields. We see very significant volatility ahead in both equity and bond markets, and this represents a major opportunity to boost both relative and absolute portfolio returns, particularly on a risk-adjusted basis.

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