The Federal Reserve’s monthly index of industrial production and the related capacity indexes and capacity utilization rates cover manufacturing, mining, and electric and gas utilities. The industrial sector, together with construction, accounts for the bulk of the variation in national output over the course of the business cycle.
The production index measures real output and is expressed as a percentage of real output in a base year, currently 2007. The capacity index, which is an estimate of sustainable potential output, is also expressed as a percentage of actual output in 2007. The rate of capacity utilization equals the seasonally adjusted output index expressed as a percentage of the related capacity index.
Industrial production figures are based on the monthly raw volume of goods produced by industrial firms such as factories, mines and electric utilities in the United States. Also included in the industrial poduction figures are the businesses of newspaper, periodical and book publishing, traditionally labeled as manufacturing.
The industrial production data is used in conjunction with various industry capacity estimates to calculate capacity utilization ratios for each line of business. Aggregate utilization ratios are also provided for areas such as total manufacturing and total high-tech production
The industrial production and related capacity utilization figures are considered coincident indicators, meaning that changes in the levels of these indicators usually reflect similar changes in overall economic activity, and therefore gross domestic product (GDP). The release will show percentage changes on month-to-month and year-over-year levels, shedding light on short-term rates of change and business cycle growth, respectively.
The Federal Reserve watches this figure closely because it understands that inflation shows itself first at the industrial level, when supplies of basic materials get tight – either for their manufacturers or for the corporate clients who buy them. Rises in the cost of commodities and materials will begin to get passed on down the line, ending up with individual consumers of higher-cost finished products.
Also, the industrial sector exhibits the most volatility in terms of nominal output during a business cycle peak to trough. As a result, big changes here have been a historical forecaster of business cycle inflection points.
Capacity utilization levels, although technically upper bound by 100%, don’t approach this value. Utilization levels above 82-85% are seen as “tight” and forecast price increases or supply shortages in the near future. Levels below 80% mean there is some slack in the economy, which could lead to recession worries and employment losses.
As with many indicators, Wall Street will have a perceived “consensus number” before the release. If the difference is larger than expected, stock and bond markets will react in the short term. A higher-than-expected number during a time of economic expansion will cause inflationary fears. If the economy is lagging, an upside surprise in the release could trigger the purchase of equities on the hope of a turnaround. The reverse is also true; lower-than-expected numbers during a time when fears of economic overheating already exist could provide a short-term lift to stock and bond prices.
This report can be used to see what specific areas of industrial production are doing better than others. This can lead investors to an analysis of supply chains and which sectors could be benefiting – or suffering – based on the trends in industrial production.
Sector breakdown allows for inspection of the relative performance of many lines of business, such as electronics, chemicals and basic metals. Press releases will include valuable analysis, which removes overly volatile components to provide a more relevant trendline and puts current numbers into perspective.
It should be noted that industrial production only deals with physical goods-producing industries, which make up less than half of economic output. Services, as well as construction production, are not included.
The capacity numbers are drawn from many different sources, and sometimes pure estimates are used when no information is available. Historical comparisons are also made difficult by heavy transition of component industries, as well as the changing demographics of U.S. output as a whole (manufacturing output is in a constant decline as a % of GNP).