Industrial production in the United States has been holding steady for the past few months. The latest figures are encouraging, with a 0.6% improvement in June, but it is too early to treat this as an uptrend. Industrial production currently accounts for 19% of U.S. GDP and is a good leading indicator of the economic cycle. It is particularly useful in identifying when the economy turns a corner and starts expanding or, alternatively, contracting.
When industrial production dropped sharply at the end of 2015 and in early 2016, investors saw this as a possible sign of recession. But the slowdown was really caused by the collapse in oil prices and energy production. This explained the poor industrial production figures and provided reassurance that the rest of the economy would not be affected. Indeed, the economy continued to be powered by the services sector, itself buoyed by high consumer spending.
The breakdown of industrial production by market group is a fair reflection of the strengths and weaknesses of the US economy:
Construction supplies has expanded by an average of 1.4% year on year since the start of 2016, in step with growth in the property sector over the same period. This group only accounts for 5% of total industrial production, however.
Consumer goods, which includes automobiles, electronics and food and represents 30% of total industrial production, has been expanding at an average pace of 68% year on year since the start of 2016. Automobile manufacturing (+7.4%) has been particularly strong. Again, these figures are in line with solid consumer spending, which is driving domestic growth.
On the other hand, business equipment and defence & space equipment – 14% of total production – have struggled in 2016. This is mainly due to very low capacity utilisation, around 75.4%. Demand is simply not strong enough to keep companies operating at full productive capacity, and this puts a damper on their need for machines and other capital goods. Weak demand for capital goods is also a result of increased spending by firms on intangible capital, including IT systems, technological progress (the cloud, cyber security), organisational knowledge and R&D. It is hard to quantify spending on intangible capital, but a number of papers published by the Federal Reserve suggest that it is approximately equal to spending on fixed capital.
With machinery orders down and exports hurt by the strong dollar, business equipment is likely to bring down overall industrial production figures.
Finally, energy materials (including oil and gas) and non-energy materials for intermediate goods are sharply down year on year. This owes largely to the pullback in oil production. These two sectors account for 45% of total industrial production and weighed heavily on the overall figures. That said, some companies in the energy sector will ramp up production following the recent rise in oil prices. Initial signs of this are apparent in the latest production figures and rig count.
 Corrado, Hulten and Sichel, ”Intangible Capital and U.S. Economic Growth”, 2009
We expect capital spending to grow by only 1.8% on average in 2016 (versus +4.1% in 2015). The impact on orders for capital goods will weigh further on total industrial production.
Industrial production is more likely to find support in rising (or even stable) energy prices. This, along with the strength of consumer goods and construction supplies, could help push the overall year-on-year figure back into positive territory before the end of 2016.