It's Already a Recession in Manufacturing According to Industrial Production

Summary

With industrial production having fallen in six of the past eight months, the largest of which being November and December, it is evident that the manufacturing sector is already in recession. To the extent that there is good news in this, it is that firms are playing it smart and not overproducing.

Wise to the Game, U.S. Manufacturers Playing it Smart

Overall industrial production fell 0.7% in December while November's initially reported decline of 0.2% was tripled to a decline of 0.6%. This is not an encouraging report for industrial activity particularly for the manufacturing sector which comprises roughly three quarters of all output and where the decline in December was a larger 1.3%. Mining output slowed a comparatively modest 0.9%. The arctic chill in December boosted utility output which offset some of the weakness in manufacturing.

Manufacturers are not blind to the challenges they face. Slower demand for consumer goods, higher borrowing costs and fear of recession are all weighing on activity. In our own discussions with clients, many of them have been intrigued by the deviating dynamic between a slowing in U.S. industrial production and still elevated industrial backlogs and trying to figure out when those will converge.

In thinking about that question, a key concept to keep in mind is that prices play a role in backlogs. Applying a price adjustment takes some of the moxie out of the apparent strength in backlogs. The nearby chart plots the year-over-year change in manufacturing production from this report alongside unfilled orders of core capital goods (from the durable goods report) adjusted for price changes using the private equipment line (from the PPI report).

The upshot is that unfilled orders have been trending lower for the past year or, in plainer terms, the backlog picture is not nearly as bright as it may appear on a nominal basis. It is not as though there is a long order list for firms to work through as activity slows. On that basis, U.S. manufacturers are playing it smart; they're not overproducing into a slowdown.

Capacity utilization slipped to 78.8% in December, marking the lowest rate in a year. There was broad-based weakness with 17 of 20 industries reporting declines, but there were still pockets that stand out to us. Some industries that saw a run up in activity throughout the pandemic have started to reverse. Consider capacity utilization in the furniture industry, for example, which has declined in nine of the past ten months and is around 9% below pre-pandemic levels as of December. Utilization in the computer & electronics industry has slipped in 12 of the past 14 months and is around 6% below pre-pandemic levels. The tide is turning in manufacturing, particularly for categories that saw robust growth during the pandemic.

Looking ahead, survey evidence is also not encouraging. The ISM manufacturing new orders index slipped further into contraction territory in December, and the only regional survey to come out yet for January was also pretty daunting. The New York Fed's Empire Manufacturing survey slid to -32.9 in January (chart). This index of general business conditions has only ever been lower four times, twice during the pandemic (Apr/May 2020) and twice during the 2008 financial crisis (Feb/Mar 2009).

Overall, while we suspect the slowdown in activity doesn't bode well for overall economic growth, the fact that manufacturers are more 'wise to the game' this cycle suggests they may be better positioned to weather an economic slowdown.