IP Trend Turns Higher

Output and capacity: IP rose by 0.8% in August and manufacturing capacity rose for the second month in a row. For MFG, utilized capacity is just at 66.6% barely two thirds of the capacity put in place. However, even going back to the overheated sixties when capacity use rates were higher, capacity utilization has never triggered a reading above 91.6. Still, it’s a lot of capacity that is left unused and the economy is not exactly scooping up the excess at a rapid rate. Manufacturing capacity use rose from 65.1 in June to 66.1 in July and to 66.6 in August.

Manufacturing: Manufacturing output rose by 0.6% in August lead by a 0.7% gain in nondurable goods. But durable good output rose by 0.4% and that was on top of a gain of 1.4% the month before that, implying a bit more momentum.

By sector: Consumer goods output rose, led by the output automobiles and products. Business equipment output rose led by the key transportation sector. Materials output rose led by output in the energy sector, although nondurables goods ex-energy output also moved up strongly in the month. Consumer goods business equipment and materials output all are up for two months running.

Caution about the impact of this strong growth on GDP: In the quarter to date, with two of three-month’s data in place, industrial output is up at a 3.4% pace and MFG output is up at a strong 5.7% pace. While these are strong numbers let me caution you that IP figures do not easily translate into GDP growth. You have treat the IP report as if it is an ‘indicator.’ We measure GDP in the United States from the expenditure side not from the output side and so the IP report per se does not feed into GDP. One clear issue is that the IP report uses different seasonal factors and they are real different for the auto sector. Still, taken and an indicator, the fact that IP is growing at a 3.4% annual rate and MFG at a 5.7% annual rate suggests that there is a lot of life to GDP. We would expect to find this output either sold to US consumers, bought by US businesses, sold overseas as exports or sitting on shelves as inventories (…although inventory data are so weak that the last option seems less likely and is more there for the sake of completing the taxonomy of options). So while that accounting is correct what GDP finds may be different from what IP implies.

What’s still weak? What is still weak in the third quarter is consumer goods output excluding autos as that metric has output falling at a 4.2% pace in Q3; the output of consumer energy goods also is falling at a pace of 12.3% in Q3. In the business sector, the output of computers and office equipment is falling in Q3 and in the materials sector, the output of energy products is falling.

But by and large the strength in the industrial sector is impressive and its momentum into Q3 appears to be quite solid.

Headline rises 0.4% core rises 0.1% for second month in a row

The summary table shows that inflation remains contained for the most part. Energy prices rose 8.5% in August slamming the headline and lien items with energy in them. But core CPI trends remain controlled. Inflation diffusion rose above 50 to 58.9 in August implying that inflation rose m/m in more CPI categories than it fell. But core diffusion was at 48.6 implying that inflation FELL m/m in more CORE categories in which it rose and that was with the core pace at +0.1%. That is pretty impressive.

Over three-months: Red figures in the table above flag four top panel categories as having accelerating inflation over three-months: Food and beverages where inflation has ‘risen’ to -0.2% from -1.1% over six months; Housing where at -0.6% over three months inflation compares to a pace of -0.8% over six months; Apparel and upkeep where the inflation’s pace shot up to 4.8% over three-months compared to 1.2% over six months; and, transportation where energy prices are at work driving the price index up at a 30% pace over three-months compared to 12.6% over six months. On balance these are not worrisome developments Transportation is mostly energy prices, housing costs are tame despite being hit by rising utilities and energy costs, food and beverage prices are still falling despite ‘accelerating.’ Apparel prices we will see about; but the series is very volatile and prices tend to run hot and cold without much trend; indeed despite the high 3-month trend, apparel prices fell in the month are up by only 0.6% Yr/yr.

These observations underscore several points: that energy inflation is not always passed along and that it is hard to tell price volatility from true inflation in the month-to-month reports. So we use the diffusion results to help guide us and they are very good this month.

Core Services: Core inflation for services (excluding energy) appears to be mostly steady at the 1.5% level or so. Twelve month six-month and three-month inflation trends all converge around that 1.5% pace which is a very low pace for the service sector where productivity is lower than for goods making input price pressures harder to fight-off. Still, all that is going well.

Core Goods: Core goods inflation (excluding food and energy) had spurted early in the year but it is settling down. Three-month and Yr/Yr inflation rates are right at the 1% mark but over six months core goods inflation is still a bit higher at 2.7%, and it is still coming down from its cyclical peak rate. The trends are good.

The EMU HICP finalized with August’s headline rate rising by 0.5% in and still dropping by 0.2% Yr/Yr. Core prices rose by 0.2% in August and rose by 1.2% Yr/Yr – a moderate result and indicating that inflation pressures are within the ECB’s HICP ceiling constraint. With headline inflation DOWN Yr/Yr the headline constraint is not going to be an issue for a while. Keeping inflation below 2% will be easy. But the core rate will provide better guidance as to what true inflation trends are doing when the energy sector is not bashing the headline rate hither and thither each month like a tennis ball caught in a long rally.

So far the picture is still a good one. Goods sector inflation is down by 1.5% Yr/Yr while service sector inflation is at 1.8% Yr/Yr. Goods inflation is off in the recent three-months but service sector inflation has locked in an increasing trend with six month inflation at 3.1% and three-month services inflation at 4.7%. That trend is a more than a bit uncomfortable.

At the country level core inflation (excluding food, energy and alcohol) is well behaved over twelve months with Germany France Italy and Spain each with 12-month rates below 1.5%. But over the shorter horizons things get dicey. Only Italy shows a core rate that is not accelerating. There the core HICP is up by 0.7% over three-months when annualized. For Germany, France and Spain core inflation has accelerated to a pace of 1.6%, 1.4% and 1.9% respectively. Those are uncomfortable results.

Europe remains a troubled economic zone, even as it is engaged in the recovery process. Recovery is not instantaneous; those who are displaced have to live through the process until they are re-engaged in economic activity. And the weaker than expected IFO survey for Germany has economists thinking that the EMU recovery will be slower rather than faster. Still at such an early stage of recovery and with the upswing still nascent, the ECB’s ceiling for headline inflation at 2% implies a lot of room for discretion but the core rates are doing things that are troublesome and testing that flexibility. It will be interesting to see how the ECB handles this delicate proposition. At least it has a rising exchange rate to help fend of any imported inflation. With the headline rate under wraps The ECB does have some time, but when nettlesome inflation trends are present the ECB has not been known for its patience. Yet the currency is so strong that the ECB probably does not want to signal that it is closer to the upside of the cycle for interest rates. The ECB has a dilemma in the making. Core inflation trends yet could evaporate. But unless they do the ECB is on a collision course with some hard and unpopular decisions.