Why industrial production levels are normalizing as weather eases

Industrial production

Industrial production recorded its largest increase since the end of December 2013 in February, signaling that the economy is gaining momentum after being dampened by severe weather.

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What is the Industrial Production Index?

The monthly index of industrial production and the related capacity indexes are important metrics of the country’s manufacturing sector. The index measures the real output of all manufacturing, mining, electric, and gas utility establishments in the U.S. Every month, the industrial production data is constructed using two base sources: output, measured in physical units, and data on inputs to the production process. The former is commonly referred as “the index of industrial production,” and it shows how much factories, mines, and utilities are producing. The latter source explains how much factory capacity is in use, referred as “the capacity utilization rate index.”

The data is based on the Fisher ideal index formula, and it’s expressed as a percentage of real output in a base year, which is currently 2007. The index is prepared by the Federal Reserve Board of Governors and is generally published on the 15th day of each month.

What did the latest reading indicate?

Industrial production beat market expectations in the February readings. The index reported 0.6% growth after dipping 0.2% in January.

Of the major components covered under the index, the manufacturing and mining sector rebounded, while utilities somewhat dropped. Manufacturing was well above analysts’ expectations of 0.3%—the actual growth reported was 0.6% in February, compared to a decline of 0.2% in January. Mining rose, but not at the same pace as it had in January. Utilities slipped 0.2% after strong growth of 3.8% in January.

Both durable and non-durable production rose

According to the Fed, production levels normalized in February after staying depressed in January due to severe weather conditions. Durable goods, particularly the output of motor vehicles and parts, advanced sharply, by 4.8%. Non-durable goods recovered from the lows of January’s weather-affected data, by 0.7%. Manufacturers apparently made a strong effort to boost production after losses in January. Capacity utilization improved to 78.8% from 78.5% in January—slightly below consensus.

How did markets react to the industrial production data releases?

Bond markets (BND) are a completely different breed in the investment world. The asset class doesn’t enjoy growth as much as the stock market (SPY). For the bond market, the concern is always whether the economy has grown enough, which may lead to increases in interest rates. The economy tries to walk that fine line between growth and inflation. Other things being equal, if inflation increases, the Fed increases interest rates. If interest rates go up, bond prices decline.

While the stock market remains more positive towards growth, inflation pressure can suppress stock markets too. Other things being equal, growth in industrial production will spur economic growth, which supports the Fed’s tapering of its asset purchases. Tapering will reduce liquidity in the market, thereby pushing interest rates upward and, in turn, pushing bond prices downward.

Increases in industrial production are likely to benefit companies such as Alpha Natural Resources (ANR) and major auto parts manufacturers like O’Reilly Automotive Inc. (ORLY) and AutoZone Inc. (AZO).

While two major manufacturing indicators released during the week have supported economic growth, how does the housing market feel about the economy? To find out more, read on to the next part of this series.