Industrial production (IP) rose a robust 1.3% in October, which was considerably stronger than the 0.2% rise expected within financial markets. However, the unexpected strength largely reflected the fact that the decline in activity in September was revised to show an even deeper 3.7% drop (compared to an originally reported -2.8%). The increase in October allowed the capacity utilization rate to rise to 76.4% from 75.5% in September, although the rate is considerably down from the 78.5% that prevailed in August.
The large swings in industrial production in recent months are largely a reflection of the transitory effects of the hurricanes that struck the Gulf region in September. The impact was clearly evident in the 8.5% drop in mining activity in September along with a 3.7% decline in manufacturing output. The October data were expected to show a sizeable reversal of this weakness as the fallout from the hurricanes subsided, although tempered by indications of underlying weakness in manufacturing. This was largely evident in the October data with mining activity up 6.1% while manufacturing output only managed to rise 0.6%. The third main component of IP, utilities output, rose 0.4% in October after a 2.4% gain in September.
Although the 1.3% rise in industrial production was larger than expected, it still only modestly retraced the hurricane-related 3.7% drop that occurred in September. That activity did not result in more of a bounce-back is an indication of underlying weakness in the manufacturing sector. This sector had earlier been supported by solid export growth, but this strength is being eroded by weakening activity externally and the recent appreciation of the U.S. dollar.
With the original weakness in residential investment now spreading to other key sectors of the economy as recessionary conditions deepen, the Fed will be pressured to keep policy accommodative. We are assuming that Fed funds will be maintained at a current very stimulative 1.00% through next year supplemented by central bank actions to inject liquidity into specific markets as pressures emerge. As well, there is the growing likelihood that the new Obama administration will opt for a second fiscal stimulus package.
RBC Financial Group
