A Publication of the National Association of Manufacturers
September 22, 2014
NAM/IndustryWeek Survey of Manufactures Business Outlook by Quarter, 2012-2014

Manufacturing production declined unexpectedly in August, led lower by reduced motor vehicle output. This drop was likely the result of automakers’ switching over to a new model year and summer vacations. Indeed, auto production has risen 8.1 percent over the past 12 months, continuing to make it one of the bright spots in the economy. Excluding autos, manufacturing output rose 0.1 percent, suggesting slightly better news for the broader sector. Still, the larger story is the accelerated pace of output seen since the winter months, with the year-over-year pace up from 1.6 percent in January to 4.0 percent in August. Durable and nondurable goods production has increased 5.6 percent and 2.2 percent year-over-year, respectively. Hopefully, the August figures reflect a brief pause before picking up again in September.

Regional sentiment surveys tend to suggest that this might be the case. The Empire State Manufacturing Survey from the New York Federal Reserve Bank said that business conditions rose at their fastest pace in nearly five years, with 46 percent of those taking the survey saying that the environment had improved in the month. At the same time, the Philadelphia Federal Reserve Bank’s Manufacturing Business Outlook Survey found healthy rates of growth in September, even as the pace pulled back slightly from very strong gains in August. Each of these two surveys reported higher levels for new orders and shipments, but they were mixed regarding hiring growth. Nonetheless, manufacturers in both districts were overwhelming upbeat about the next six months, with more than half of respondents predicting sales increases. Moreover, the Philly Fed found that a majority of those taking its survey expect production to increase in the third and fourth quarters.

Meanwhile, housing starts fell from an annualized 1,117,000 units in July to 956,000 in August. To be fair, the July figure—the second fastest pace since November 2007—was likely an outlier, and the pendulum—not unexpectedly—swung back somewhat. Yet, the slowdown in August was still disappointing. On the bright side, while single-family and multi-family unit starts and permits were both down, the highly volatile multi-family segment comprised the bulk of the decline. Looking at a longer time horizon, each has continued a slow, but steady upward trajectory. I continue to expect housing starts to be solidly at 1.1 million by year’s end. Indeed, home-builder confidence was equally optimistic about better figures moving forward, with the Housing Market Index at its highest level since November 2005.  

The Federal Reserve Board provided the other major headline from last week. The Federal Open Market Committee (FOMC) began laying out its principles for winding down the extraordinary stimulus that it has pursued since the financial crisis at the end of 2008. The Fed will end its purchases of long-term and mortgage-backed securities after its October FOMC meeting, and the expectation is that short-term interest rates will begin to “normalize” at some point in 2015. The federal funds rate, however, will remain near zero for a “considerable time after the asset purchase program ends,” a statement that some suggest means that normalization will not occur until mid-2015 at the earliest. Fortunately, news that consumer and producer pricing pressures eased in August was likely welcomed at the FOMC because it takes some pressure off of the Fed to act sooner, at least for now. (Inflation has accelerated from where it was earlier in the year, but remains below the Fed’s stated 2.0 percent goal.)

In its FOMC statement, the Federal Reserve said that “economic activity is expanding at a moderate pace.” Nonetheless, it continues to worry about slack in the economy, particularly in labor markets. The Fed predicts growth this year of between 2.0 and 2.2 percent, with 2.6 to 3.0 percent real GDP growth next year. The unemployment rate is expected to fall to 5.9 or 6.0 percent by the end of 2014 and 5.4 to 5.6 percent by the end of 2015. In terms of inflation, the Fed forecasts prices growing by less than 2.0 percent over the next few years. If core inflation consistently exceeds 2.0 percent, it will give greater credence to hawks on the FOMC to increase rates sooner rather than later.

This week, we will get a sense of how manufacturing activity is faring globally with preliminary purchasing managers’ index (PMI) data from Markit for China, the Eurozone and the United States. The Chinese economy has begun to stabilize after slowing earlier in the year, but is still not growing by much. European growth has effectively come to a halt. In the United States, however, recent PMI data have reflected healthy gains in both demand and output over the summer months. We will also get new surveys from the Kansas City and Richmond Federal Reserve banks. Beyond those surveys, we will get the second revision to real GDP growth for the second quarter on Friday, with a consensus estimate of 4.3 percent growth, or just slightly higher than the previous 4.2 percent figure.

Other highlights this week include the latest data on consumer confidence, durable goods orders and shipments, and existing and new home sales.

Chad Moutray
Chief Economist
National Association of Manufacturers
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Economic Indicators
Last Week's Indicators:
(Summaries Appear Below)

Monday, September 15
Industrial Production
NY Fed Empire State Manufacturing Survey

Tuesday, September 16
Producer Price Index

Wednesday, September 17
Consumer Price Index
FOMC Monetary Policy Statement
NAHB Housing Market Index

Thursday, September 18
Housing Starts and Permits
Philadelphia Fed Manufacturing Survey

Friday, September 19
Conference Board Leading Economic Indicators
State Employment Report

This Week's Indicators:

Monday, September 22

Chicago Fed National Activity Index
Existing Home Sales

Tuesday, September 23
Markit Flash PMIs for China, Eurozone and the U.S.
Richmond Fed Manufacturing Survey

Wednesday, September 24
New Home Sales

Thursday, September 25
Durable Goods Orders and Shipments
Kansas City Fed Manufacturing Survey

Friday, September 26
Gross Domestic Product (Second Quarter Revision)
University of Michigan Consumer Sentiment Survey

Summaries for Last Week`s Economic Indicators
Conference Board Leading Economic Indicators
The Conference Board said that the Leading Economic Index (LEI) rose 0.2 percent in August. This was the seventh consecutive monthly increase; however, the pace of growth slowed considerably in August, down from 1.1 percent in July. Nonetheless, the larger trend has been encouraging, with the LEI expanding 4.3 percent year-to-date. This bodes well for the coming months.

Strength in new manufacturing orders was one of the bright spots in the August report. Indeed, the Institute for Supply Management’s purchasing managers’ index recorded healthy gains in both demand and output in August, with the new orders components suggesting robust sales growth. Other positive contributors included favorable lending conditions and the interest rate spread. In contrast, reduced building permits (see below) were one of the larger drags on the LEI in the month, with neutral contributions from both consumer confidence and the length of the average workweek.

Meanwhile, the Coincident Economic Index (CEI), which assesses current conditions, also increased 0.2 percent in August. Softer industrial production numbers (see below) provided a slight negative to the CEI for the month, but the other three subcomponents made positive contributions. This included nonfarm payrolls, personal income and manufacturing and trade sales.

Consumer Price Index
The Bureau of Labor Statistics said that consumer prices fell 0.2 percent in August, the first monthly decline since April 2013. The decrease stemmed largely from reduced energy costs, which were off 2.6 percent in August. Gasoline prices decreased 4.1 percent for the month. Indeed, we have seen the average price of regular gasoline decline from $3.47 a gallon during the week of July 28 to $3.40 a gallon for the week of August 25, according to the Energy Information Administration. It has fallen further since then, averaging $3.35 per gallon this week.

In contrast, food prices continue to rise, up 0.2 percent, albeit at a slower pace than earlier in the year. Food costs have risen 2.4 percent year-to-date, or 2.7 percent over the past 12 months. As with past months, the largest food price increases in August were for beef and veal, chicken, eggs, fish, pork and seafood. These gains were somewhat offset, however, by decreased monthly costs for fruits and vegetables and beverages.

Meanwhile, excluding food and energy items, consumer prices were unchanged, mirroring producer price index data (see below). There were higher prices for new motor vehicles and shelter, with reduced costs for apparel, household furnishings and used cars and trucks.

Overall, the consumer price index rose 1.7 percent from August 2013 to August 2014, down from the 2.0 percent pace observed in July. This suggests a slight easing in inflationary pressures, even as it still reflects an acceleration from the 1.1 percent year-over-year rate in February. Similarly, core inflation— which excludes food and energy items—was also up 1.7 percent year-over-year, down from 1.9 percent the month before.

The Federal Open Market Committee (FOMC) no doubt welcomes news that pricing pressures have lessened somewhat in August. Core inflation remains below the Federal Reserve’s stated target of 2.0 percent. Still, the FOMC will closely watch to see how pricing pressures develop in the coming months, particularly as it prepares to start normalizing short-term rates in early 2015.

FOMC Monetary Policy Statement
The FOMC began laying out its framework for “normalizing” monetary policy. In particular, the Federal Reserve plans to end its quantitative easing program next month, with its purchases of long-term and mortgage-backed securities coming to a conclusion after its October meeting. Because of these purchases, the Fed’s balance sheet has now soared to over $4.4 trillion. Moving forward, the Fed’s assets will be reduced “in a gradual and predictable manner.” That does not mean, however, that the balance sheet will return to pre-crisis levels, as it is likely to remain at elevated levels for the foreseeable future. Still, the FOMC added the following language to its guidance, perhaps to allay worries from those who suggest that the Fed’s actions have distorted the marketplace:

The Committee intends that the Federal Reserve will, in the longer run, hold no more securities than necessary to implement monetary policy efficiently and effectively, and that it will hold primarily Treasury securities, thereby minimizing the effect of Federal Reserve holdings on the allocation of credit across sectors of the economy.

Moreover, the Fed is expected to start raising short-term interest rates, which have effectively been zero since late 2008, beginning next year. The guessing game is whether that will occur in the first half or second half of 2015. The FOMC’s principles state that rates will begin to rise when “economic conditions and the economic outlook warrant” such an action. In the monetary policy statement issued at the conclusion of its September 16–17 meeting, the FOMC said that “it will take a balanced approach consistent with its longer-term goals of maximum employment and inflation of 2 percent” in deciding to normalize rates. Nonetheless, the statement continues to assert that the federal funds rate will be at its current low levels for a “considerable time after the asset purchase program ends.”

The decision to continue stimulating the economy for the foreseeable future despite progress in the economy was supported by most of the FOMC participants, who remain concerned about “slack” in the economy, particularly in labor markets. Yet, inflation hawks on the FOMC dissented with these actions. Dallas Federal Reserve Bank President Richard W. Fisher felt that the pickup in economic growth warranted less accommodative policies. Federal Reserve Bank President Charles I. Plosser objected to the long time horizon for keeping short-term rates at their current levels.

Housing Starts and Permits
The Census Bureau and the U.S. Department of Housing and Urban Development said that housing starts returned to earth in August after a strong gain in July. Housing starts soared to a revised 1,117,000 units at the annual rate in July, their second-highest pace since November 2007. This figure fell to an annualized 956,000 in August, or a decline of 14.4 percent. Still, it represented an increase from June’s 909,000 figure, and over the past 12 months, housing starts have risen 8.0 percent. As such, despite the decrease in August, residential construction activity remains on an upward trajectory, albeit one that only gradually has moved higher with a lot of volatility from month to month.

The bulk of the decline in August stemmed from a falloff in multi-family housing starts, down from 458,000 to 313,000. Multi-family starts have averaged 352,375 per month year-to-date, with the August reading being the low point so far this year. Yet, multi-family starts have risen 16.8 percent over the past 12 months. Even with such unpredictability from month to month, multi-family unit activity has trended higher.

At the same time, single-family starts were down from 659,000 in July to 643,000 in August. This figure has also increased over a longer time horizon, up from 583,000 in January and 617,000 in August 2013. As such, single-family housing starts have increased 4.2 percent year-over-year.

Meanwhile, housing permits mirrored many of these same developments, with permitting down from 1,057,000 in July to 998,000 in August. On a year-over-year basis, housing permits grew 5.3 percent since August 2013. Single-family (down from 631,000 to 626,000) and multi-family (down from 426,000 to 372,000) permits were both lower for the month, with the latter off more significantly.

Overall, the slowdown in new residential activity in August was disappointing, particularly given the strength seen in July. Moreover, it follows encouraging news on home-builder sentiment, which improved to its highest level in nearly nine years (see the NAHB Housing Market Index description below). Nonetheless, the July data were perhaps a bit too strong, and we should have expected the pendulum to swing back somewhat. Despite the decline in both starts and permits in August, the longer-term trend for housing remains positive, especially for single-family construction. 

Moving forward, August’s housing data are likely to remain above the 1 million mark, with starts solidly at 1.1 million by year’s end, representing slow but steady progress in the residential market.

Industrial Production
Manufacturing production fell 0.4 percent in August, declining unexpectedly instead of extending the strong gains of July. Much of this decline stemmed from reduced motor vehicle production (down 7.6 percent in August), but this was likely the result of automakers’ switching over to a new model year and summer vacations. Despite the decrease for the month, motor vehicle production has risen 8.1 percent over the past 12 months, the largest increase of any of the major sectors. As such, this month’s figure should not be misinterpreted as a weakness, but instead as just a pause in an otherwise upward trend for motor vehicle demand and output.  Excluding autos, manufacturing production would have increased 0.1 percent.

Manufacturing production continues to reflect an accelerated pace from the winter months, with the year-over-year pace up from 1.6 percent in January to 4.0 percent in August. Still, this pace was down from 5.2 percent in July. Durable and nondurable goods output has increased 5.6 percent and 2.2 percent year-over-year, respectively. At the same time, manufacturing capacity utilization also eased, down from 77.6 percent in July to 77.2 percent in August.

Nondurable goods production was up 0.2 percent in August, but that was offset by a decline of 0.9 percent for durable goods manufacturers. Computer and electronic products (up 1.3 percent); food, beverage and tobacco products (up 0.4 percent); nonmetallic mineral products (up 0.4 percent); machinery (up 0.3 percent); and chemicals (up 0.3 percent) were examples of sectors with increased output in August.

In contrast, sectors with declining output included apparel and leather products (down 2.3 percent); fabricated metal products (down 1.3 percent); furniture and related products (down 1.0 percent); textile and product mills (down 0.9 percent); and printing and support (down 0.6 percent).

Meanwhile, overall industrial production decreased 0.1 percent, its first decline since the weather-related slowdowns of January. Mining (up 0.5 percent) and utilities (up 1.0 percent) output were both higher. Total capacity utilization edged lower, down from 79.1 percent to 78.8 percent.  

In conclusion, manufacturers continue to be upbeat about activity in the second half of this year, but much like the jobs data a couple weeks ago, the production figures suggest softness in August. Instead of modest gains in output in August as expected, production in the sector declined 0.4 percent, mainly on slower activity in the auto sector. Nonetheless, the outlook remains mostly optimistic, and there were likely retooling issues related to the declines in motor vehicle production.

Still, manufacturers would like to see stronger economic activity moving forward, and for that reason, policymakers should focus on pro-growth initiatives that will allow them to expand and flourish.

NAHB Housing Market Index
The National Association of Home Builders (NAHB) and Wells Fargo reported that home-builder confidence was at its highest level since November 2005. The Housing Market Index (HMI) rose from 55 in August to 59 in September. Sentiment has recovered from the lull experienced from February to June time frame when the HMI fell below 50—numbers above 50 indicate that home builders are more positive than negative in their outlook. Overall, these data indicate that builders are quite upbeat in their assessments of the housing market. Looking ahead six months, the index for expected single-family sales rose from 65 to 67, its fastest pace since last August.

At the same time, NAHB Chief Economist David Crowe said that first-time home buyers were still not active in the market, preventing even stronger growth. He added, “Other factors impeding the pace of the housing recovery include persistently tight credit conditions for consumers and rising costs for materials, lots and labor.”

NY Fed Empire State Manufacturing Survey
The Empire State Manufacturing Survey from the New York Federal Reserve Bank reported a strong increase in activity in September. The composite index of general business conditions rose from 14.7 in August to 27.5 in September. It was its highest level in five years. Almost 46 percent of those taking the survey said that conditions had improved in the month. Other measures were mostly positive as well, including faster paces for new orders (up from 14.1 to 16.9) and shipments (up from 24.6 to 27.1).

Yet, there were also some challenges, most notably in the labor market. Hiring eased in September, with the index for the number of employees dropping from 13.6 to 3.3. This decline stemmed from an increase in respondents who said that their employment levels had decreased—5.7 percent reported a decline in employment in August while 16.3 percent reported a drop in September. The average employee workweek also narrowed, with its index down from 8.0 to 3.2.

Pricing pressures continued to be elevated, even as there was a marginal improvement for the month. The index for raw material prices declined slightly, down from 27.3 to 23.9, but that still represents a significant percentage of manufacturers in the Fed district seeing input costs rise. This trend is expected to continue over the next six months, with nearly 46 percent of respondents anticipating higher prices.
The other forward-looking measures continue to find a mostly optimistic outlook in the New York Fed region. There was a slight pullback in many of the measures assessing the next six months, but manufacturing leaders remain upbeat overall. In fact, 57.1 percent of those completing the survey predict sales increases, or about the same proportion as those anticipating higher shipments. Just over one quarter expect to add more workers in the coming months, with 29.4 percent planning additional capital expenditures.

Philadelphia Fed Manufacturing Survey
The Federal Reserve Bank of Philadelphia said that manufacturing activity eased slightly, but growth remained strong in its district. The Manufacturing Business Outlook Survey’s composite index of general business activity declined from 28.0 in August to 22.5 in September. While the figure decreased somewhat, it is important to note that August’s reading was the fastest pace since March 2011, and a modest pullback should have been anticipated. Many of the key indicators continued to expand at healthy rates, keeping the underlying trends positive.

As evidence of this, the paces for new orders (up from 14.7 to 15.5), shipments (up from 16.5 to 21.6) and employment (up from 9.1 to 21.2) accelerated. The percentage of respondents saying that their sales had increased in the month rose from 32.3 percent in August to 37.6 percent in September. Roughly one quarter of respondents noted additional hiring in both months, with the percentage citing declines in employment dropping from 15.6 percent to 4.5 percent. Therefore, fewer manufacturers were cutting workers in September, which is encouraging. Still, the average workweek (down from 13.3 to 4.4) narrowed a bit.

Manufacturers remained overwhelmingly upbeat in their outlook despite a decrease in the forward-looking composite measure (down from 66.4 to 56.0). In fact, 55.1 percent of respondents anticipate increased new orders in the next six months, with 58.8 percent seeing higher shipment levels. Regarding employment, 43.6 percent expect to add new workers in the coming months, with just 4.0 percent indicating possible declines. Capital spending (up from 17.5 to 23.7) was also expected to increase at decent rates. The one downside was pricing pressures for raw materials, with almost half of those taking the survey predicting higher input costs ahead.

As further evidence of this optimism, manufacturers responded to a special question about production in the third quarter. Nearly 59 percent of them said that output would increase for their company in the third quarter relative to the second quarter, with 28.7 percent stating declines. On average, production was expected to increase by 2 percent in the third quarter. For the fourth quarter, those predicting an acceleration in activity (53.8 percent) outpaced those forecasting a deceleration (21.2 percent).

Producer Price Index
The Bureau of Labor Statistics said that producer prices for final demand goods and services were unchanged in August, continuing the easing in inflationary pressures seen in July. More importantly, producer prices for final demand goods were down 0.3 percent in August, with costs for both food and energy lower for the month. Energy prices fell for the second straight month (down 1.5 percent), consistent with the drop in the price of West Texas Intermediate (WTI) crude oil from $106.07 per barrel at the end of July to $98.23 at the end of August. (WTI closed at $92.58 per barrel on Friday, indicating that there will be a further deceleration in this measure in September.)

Meanwhile, food prices decreased 0.5 percent in August. After rising 5.4 percent from December to April, producer prices for final demand food products have eased by 0.8 percent. As such, the cost of food remained 4.5 percent higher in August than at the start of the year. This has largely stemmed from higher prices for meats, eggs, dairy and produce. The largest price declines in August were seen in eggs, fish, oilseeds, pasta products and pork.

Beyond food and energy, core prices for final demand goods were unchanged. Higher monthly costs for footwear, heavy motor trucks, mobile homes, paper industries machinery, pet food and toys were offset by lower prices in computers, household appliances, metal forming machinery, office equipment, passenger cars and women’s apparel.

On an annual basis, producer prices for final demand goods and services have increased 1.8 percent over the past 12 months. This represents a decline from the 2.0 percent observed in May but an acceleration from December’s 1.1 percent pace. Likewise, core inflation—which excludes food and energy costs—for final demand goods and services has increased 1.8 percent year-over-year in August, up from 1.6 percent in July.

Overall, this report suggests that pricing pressures have accelerated from earlier in the year, but inflationary growth has eased slightly over the past couple months. Core inflation remains below the Federal Reserve’s stated threshold of 2.0 percent. This indicates the inflation remains in check, at least for now, and the recent deceleration should ease the pressure on the FOMC to expedite its plans to normalize rates. Of course, the final decision to raise short-term rates will likely hinge on economic data in the months to come.

State Employment Report
Georgia added the most net new manufacturing employees in August, according to new statewide employment data provided by the Bureau of Labor Statistics. Georgia manufacturers hired an additional 5,500 workers in the month. This was followed by Florida (up 4,500), Colorado (up 2,100), Illinois (up 2,100) and Michigan (up 2,000). On a year-to-date basis, Georgia has also fared well and is among the top five states for manufacturing job growth. The top five states for manufacturing job gains through August were Indiana (up 14,300), Ohio (up 9,400), Georgia (up 9,100), Texas (up 9,100) and Michigan (up 7,100).

Since the recession, manufacturers have added 681,000 net new workers. Michigan has added the most manufacturing employees since the end of 2009, hiring 111,300 on net. Other top states since the recession ended include Texas (up 80,100), Indiana (up 72,600), Ohio (up 61,300) and Wisconsin (up 41,600).

In terms of the unemployment rate, North Dakota’s 2.8 percent rate remains the lowest in the United States, with shale exploration continuing to pay benefits that that state’s economy. Nebraska, South Dakota and Utah also have very low unemployment rates, each with 3.6 percent of their populations unemployed. At the other end of the spectrum, Georgia (8.1 percent) has the highest unemployment rate, followed by Mississippi (7.9 percent), Rhode Island (7.7 percent), the District of Columbia (7.6 percent) and Nevada (7.6 percent).

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Contact Chief Economist Chad Moutray at cmoutray@nam.org.
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