KEY DATA: IP: +0.6%; Manufacturing: +0.8%/ PPI: +0.2%; Goods: -0.1%; Services: +0.4%; Excluding Energy: +0.3%
IN A NUTSHELL: “With the vehicle makers leading the way, the manufacturing sector is ramping up even as costs are moderating.”
WHAT IT MEANS: Despite some decent consumer spending, the manufacturing sector had been lagging. Not anymore. Industrial production soared in July as the vehicle sector decided to start ramping up output to meet the high sales pace. Assembly rates jumped by nearly 16%, to its highest level in over 35 years. But it wasn’t just automakers who saw the need to increase output: Eight of the eleven durable goods sectors and six of the eight nondurables posted gains. Whether it was business equipment, consumer goods, construction supplies or high tech products, the need to run the factory longer and faster was seen. The really weak area, not surprisingly, was petroleum. Clothing production also took a big hit and with the dollar rising, that could continue to be a problem area. Capacity utilization rose sharply, but it is not high by any means.
On the wholesale cost side, prices rose, but less than they did in May and June. The restraining factor was energy and the decline in costs is likely to accelerate given the recent drop in crude prices. Excluding energy, prices rose moderately and taking out food, costs also ticked up, though modestly. Still, even on the goods side, finished consumer goods less food and energy were up a solid 2.9% over the year. That is important to note because the major portion of the cost pressures, to what extent they exist, is coming from services. We forget about this component but it is nearly two-thirds of producer costs. Services expenses rose solidly and no major sector posted a decline. Trade, transportation, warehousing and government services all posted gains. This portion of the economy should provide a base for inflation.
MARKETS AND FED POLICY IMPLICATIONS: It would be nice if the two components of the Fed’s dual mandate were behaving consistently, but that is not happening. If you just look at the domestic economy, everything is hunky-dory (that’s a technical economic term). But on the inflation front, the falling price of petroleum and the rising value of the dollar are putting downward pressure on prices. What will the FOMC consider most important? If we look at their words, the Fed members view low inflation as a medium term issue, not an immediate problem. Thus, they are saying they can be patient, as long as expectations remain stable, which they are. Consequently, we should continue to focus on the real economy and the data imply it is strong enough to absorb a rate hike. Meanwhile, back in the markets, the wild ride is likely to continue until some semblance of order returns to the oil and currency markets. With traders worried about the issue of the day and the earnings number of moment, a longer-term viewpoint of stocks based on economic trends is not likely to dominate behavior.