Looking for an indicator to measure the health of the U.S. manufacturing sector? Learn how to analyze industrial production and capacity utilization.
If you’re looking for an indicator to measure the health of the U.S. manufacturing sector, look no further. Each month the Federal Reserve compiles and releases data that measures the output of the U.S. manufacturing, mining, and electric and gas utility sectors.
Economists at the Fed crunch the numbers and compile the data to report:
The report measures activity in the manufacturing sector, which can be cyclical and tied to changes in the business cycle. “Unlike the services side of the economy, manufacturing moves more acutely with the business cycle," says Patrick O’Hare, chief market analyst at Briefing.com.
One of the biggest components within the manufacturing sector is the auto industry, O’Hare says. “This report on motor vehicle assemblies offers nice insight into how demand is tracking for autos. It’s a good indicator of what is going on right now."
Report name: Industrial Production and Capacity UtilizationReleased by: The Federal Reserve Release date: Around the middle of the monthRelease time: 9:15 a.m. ET
Best trait: The capacity utilization index indicates how much spare capacity exists within a given group, O’Hare says. “A high rate of capacity utilization could trigger worries about production bottlenecks and price increases. It would promote increased business investment as businesses try to expand to meet demand."
On the flip side, a declining or weak capacity utilization number suggests the nation is unlikely to see an increase in business investment.
One weakness: Capacity utilization data can be “difficult to measure," O’Hare says. “They are really best estimates of how much is being utilized."
Also, the Fed generally reports the data when roughly 70% of the numbers are in, O’Hare says. “It’s not exactly a complete picture when reported. This leaves capacity utilization susceptible to revisions in subsequent months. A lot of economists look at a three-month moving average of the data set to make stronger declarations on output."
Another weakness of the capacity utilization report is that it only measures operations within the U.S. “A lot of manufacturing now takes place abroad. It’s not a complete picture of what is going on in the production capacity," O’Hare explains.
Tradability rating: (a) Tends to be ignored. (b) Depends on overall trading climate. (c) Don’t miss this one.
Lately, O’Hare ranks this report as a fairly muted market mover, in the 4 to 5 region on a 1 to 10 scale. Recently the capacity utilization number has registered readings near the 75% level. If that capacity utilization number bumps up toward 80%, markets and traders will take notice, O’Hare says. “The 80% level is recognized as where production bottlenecks can occur and inflation pressures can pick up," he says.
Current read: It’s no secret that the manufacturing sector of the economy has been on the weak side. “Industrial production hasn’t been all that terrific," O’Hare says. On a year-over-year basis through May, industrial production is down 1.4%. “Some of that is related to the persistent decline in mining output related to energy commodities. We are still not seeing a whole lot of strength on the manufacturing side of the economy."
The capacity utilization rate—at 74.9% recently—is below the long-run average of 80% that was seen from 1972 to 2015.
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