Industrial Production May 2024: Capacity Utilization

Industrial Production and Capacity Utilization weigh in with some decent numbers, but Retail Sales carries the day for the UST curve.

Life as a bull in a world of tariff uncertainty and crazy politics.

• We look at the latest capacity utilization trend line in total and across manufacturing and some bellwether industry groups.

• The May numbers show a broad array of increases across the high level groupings and major industry line items.

• Total Industry saw “cap ute” rise sequentially as did Total Manufacturing, Durables, and Nondurables.

• The takeaway is that Manufacturing is not cooperating with the UST bulls just yet even if the consumer is giving a rate cut tease.

In a market that has been tough on bulls and bears alike (tough on the UST bulls, kind to the equity bulls), it seems you are only as good as your recent macro data point since the micro stories have been constructive. Today brought a tepid Retail Sales release, but in the manufacturing sector and the Industrial Production release we see broad (if mild) sequential upticks in the major industry lines we track each month.

 If last month was a softer release (See Industrial Production May 2024: Another Softer Spot 5-16-24), this month shows pockets of strength in some cases or the absence of weakness for others. For Total Industry and Total Manufacturing capacity utilization, the market is still running below the long-term average, but the MoM uptick signals stability and strength for some of the lines.

In economic growth themes, the old rule is “tie goes to the consumer” as PCE leads by a long shot in GDP weight and factors more into the demand side of so many key lines in the PCE and CPI index.  The downward revision in the PCE line of the 1Q24 GDP release (see 1Q24 GDP: Second Estimate, Moving Parts 5-30-24) was the start of more discussion around a potential plateau on the consumer, but the jobs numbers typically rattle the UST comfort zone.

Consumer sentiment has been grim (see Consumer Sentiment: Summer Blues or Election Vibecession 6-14-24) and consumption undershot income in the most recent PCE data (see PCE, Income and Outlays: Lower Income and Consumption, Sideways Inflation 5-31-24 ). Few would be willing to place a major bet on recession or economic contraction without signs of PCE declines and a payroll fade. Those are not on the horizon yet (at least under the current tariff backdrop).

Manufacturing is holding in well as noted above with the MoM deltas of the major groups we track all in the positive range. Looking back to May 2023 shows some fade in manufacturing. Durables are fighting a battle to hold the line, and Durables are seeing deflation in the inflation metrics. Durables pricing is the swing vote on volumes.

The recent tariff policy actions are rolling into various industry groups with China the main target, but there is more drama ahead in tariffs as we have been covering recently. Post-election tariff threats are still months away before they would be felt  when (or if ) enacted (see Income Taxes for Tariffs: Dollars to Donuts 6-14-24, Trade Flows: More Clarity Needed to Handicap Major Trade Risks 6-11-24). Some of the tariff craziness being tossed around is intrinsically inflationary or earnings dilutive unless you are among those most skilled in disinformation strategies (or dumber than a rock). 

Under Trump, Gary Cohn called them “a tax on the consumers” and “a tax on Americans.”  In contrast, the RNC recently said that “The notion that tariffs are a tax on U.S. consumers is a lie pushed by outsourcers and the Chinese Communist Party.” (The Best and Brightest hard at work...) The GOP-dominated Chamber of Commerce said the exact opposite of that in 2018 and see it as a tax and expense to the US manufacturers. The National Association of Manufacturers said the same in substance back in 2019 and later. The manufacturers are the ones that do the hiring and investment in capex. The RNC does not invest in manufacturing. The RNC invests in political themes, vote gathering and misinformation channels.

In the end, consumers vote in the aisles (and the showrooms/parking lots and online) but also at the ballot box. Maybe the disinformation will get cleared up in the debate between two protectionist candidates?  Forecasting PCE contraction in 2025 gets easier if such adverse price, cost, and supply distortions get rolled into place.  In politics, if the rationale sells, then it is good politics. When it fails, deny and deflect. Washington 101.

The above chart lines up the median capacity utilization levels for expansion and recession periods using NBER dates. With the exceptions of the current cycle and the month of May 2024 on the left of the chart, we line the medians up in ascending order.  On the left side we look at averages for expansions and on the right side we look at recessions.

The impressive aspect of the cap ute levels in recent cycles is how profitable many manufacturers are at cap ute levels below most past recessions.  That is where break-even volumes kick into gear for a given price level, cost structure, and product/service mix. The capacity rationalizations, restructurings and operational overhauls of the crisis years and some additional action with COVID is how many manufacturing operations “got lean.”  For many industries and companies, the restructuring of supplier chains was part of that.  

Policy makers can run their tariff plans by focus groups (even if a focus “group of one guy” with an orange face), but the economics of production and supplier chains rule the income statement and cash flow and the capital budgeting decisions. The tariffs hit the cost structure since the “buyer pays” and the market clearing prices get tested (heavy on the consumer) for those companies planning to recover their higher costs.

To the extent those supplier chains have been built up over many years, they cannot be unwound over a single or a couple of election cycles. Uncertainty promotes defensiveness in capex as the Trump team found out in 2018-2019. The 2018 financial market performance was awful while 2019 required 3 Fed easings largely tied to poor corporate investment to boost that market (see Histories: Asset Return Journey from 2016 to 2023 1-22-24). Manufacturing and capital intensive require confidence and predictability to invest.

The above chart is informational and recaps the capacity utilization levels and Hi-Lo swings across past economic cycles. For Manufacturing, the LTM median of 77.3% is below the long term median since 1967 of 78.6%.  The 1980s expansion posted a 79.5% median and the 1990s expansion posted a median of 81.1%.  The recession data tells an interesting story of how much progress has been made on breakeven rates in a much more efficient manufacturing sector. 

Policy can unwind that progress, but it will come at a price no one will talk about (honestly, that is). Every policy action comes at a cost and (sometimes) with a benefit. You should not lie to voters about the choices, but of course you can if you want to. Some voters don’t seem to mind (it beats thinking).

See also:

Footnotes & Flashbacks: State of Yields 6-16-24

Footnotes & Flashbacks: Asset Returns 6-16-24

Consumer Sentiment: Summer Blues or Election Vibecession 6-14-24

Income Taxes for Tariffs: Dollars to Donuts 6-14-24

HY Spreads: The BB vs. BBB Spread Compression 6-13-24

HY Spreads: Celebrating Tumultuous Times at a Credit Peak 6-13-24

FOMC: There Can Be Only One 6-12-24

May 2024 CPI: I Feel Good, Not Sure That I Should 6-12-24

Trade Flows: More Clarity Needed to Handicap Major Trade Risks 6-11-24