Posted July 27, 2023

Economists: Industrial Production Report was a gut punch 

By Tim Quinlan and Shannon Seery, Wells Fargo Economics Group

This is not the sort of triple play you want to see. Manufacturing, utilities & mining production all fell for a second-straight month in June. This highlights the tough job for the FOMC: raise rates enough to slow the jobs market and take the swagger out of consumer spending without causing collateral damage in the industrial sector.

Back-to-Back Monthly Declines Across the Board

The June Industrial Production report was a gut punch. Overall output dropped 0.5%, which would have been the steepest decline of the year except that last month's initially reported decline of 0.2% was revised lower to a drop that precisely matched June; the upshot is back-to-back monthly declines in industrial production of 0.5%.

The ongoing challenge for the FOMC is to administer just enough policy tightening to slow the jobs market and increase the cost of capital enough to take the swagger out of consumer spending and thus tame inflation without causing collateral damage in the industrial sector. Today's ugly industrial production report for June, especially in the context of the mostly upbeat retail sales release puts this challenge in stark contrast.

Higher rates mean increased cost of borrowing for big-ticket durable goods. Little surprise then to see firms have scaled back consumer goods production for a second straight month. In fact, even over the past year, consumer goods production is down 0.7%. The pullback in consumer product is also evident in the trade data with real consumer goods imports down about 13% year-to-date through May.

Silver linings were tough to find with manufacturing down 0.3%, utilities off 2.6% and mining activity slowing 0.2%.

What Looked Like a Reprieve Got Revised Away

We had been expecting somewhat of a bounce in utilities output after two consecutive monthly declines, warmer-than-usual weather, and thick smoke from Canadian wildfires blanketing the Northeast. The opposite happened. Utilities output slid 2.6% in June, and the past three consecutive months have now completely reversed the unusually large pop we saw in May.

Manufacturing output slid 0.3%, and the gain in May was revised away to show a 0.2% drop taking with it some of the recent reprieve we were seeing in the industrial space.

Survey data, whether it is the national ISM manufacturing index or regional PMIs, continue to demonstrate pessimism and weak activity. But a third straight increase in durable goods orders pointed to a potential bottoming in capex spending, which would bode well for manufacturing. Weakness in June was rather broad based with the largest decline coming from motor vehicle & parts, which slipped 3.0%. Auto production and sales can be volatile month-to-month. Consider that auto production jumped about 10% just two months earlier in April, suggesting further payback is likely. But the pullback in June supports our view that auto sales are slowing amid unfavorable buying conditions. Even stripping away autos, manufacturing was down 0.1% last month.

One area that continues to buck the trend in manufacturing is high-technology industries. Production in these selected industries represents a relatively small portion of overall IP (around 2%), but it is growing. It rose 1.2% in June, the fifth straight monthly gain, and supports the sustained rise we've seen in intellectual property products investment and manufacturing construction despite a pullback in more traditional cap-ex investment like equipment. More broadly, businesses which find workers too scarce, or too expensive, today may throw more money into technology. Further investment in this space is a rare bright spot amid the shoring up of key technologies and supply chains.