Today's US data further suggests the Fed has done enough

Disappointing industrial production numbers from the US today, falling by 0.6% on the month against an expected decline of 0.4%. However, much of this fall was the result of an approximate 10% decline in vehicle output, the result of strike action taken recently by the Union of Auto Workers (UAW). Strip vehicle production out of the numbers and production actually rose by 0.1%. The UAW strikes finished at the end of last month, suggesting that manufacturing output should mean-revert for the November numbers. However, even removing the UAW impact, the picture being painted is one of flat-lining activity and survey evidence suggests it is a picture that is going to persist for a while yet. The impact of falling capital expenditure plans which have been seen for a while now is clearly having an effect on corporate America, and even though such spending intentions are no longer falling, they are so far showing no material signs of picking up. And it has to also be remembered that this somewhat downbeat outlook is being accompanied by higher costs of borrowing and falling bank lending, a far from conducive environment for companies to increase spending in. It is just one more piece of evidence pointing to the drag on activity that the Fed’s monetary tightening is causing, and with yesterday’s retail sales figures providing an early sign that consumers are also starting to wilt under the tighter financial conditions, it may not be very long before the market starts to openly push back on the Fed’s message of “higher for longer”.

Separately, today’s initial jobless claims numbers rose to their highest level for some three months – 231K - and even though they remain below the 265K high seen in June, the direction of travel is clearly upwards. In many ways, today’s industrial production numbers paint a clear picture for why jobless claims should be rising. The higher cost of finance is depressing corporate investment, and with it plans for expanding workforces. Furthermore, signs of slowing demand, such as yesterday’s retail sales figures, point to falling gross margins, which will mean firms seeking to cut costs in order to protect net margins, with labour costs typically the first item of expenditure to be cut back on. The pieces of the puzzle are all in place for jobless claims to continue rising, putting downwards pressure on the payrolls number and pushing upwards the unemployment rate – and in turn making it harder for the Fed to justify keeping the current tight monetary policy in place.

All in all, the US data released this week paints a picture of inflationary pressures receding and growth slowing. While the Fed will likely claim it needs a longer run of such data before it can be absolutely sure the battle against inflation has been won, a soft payrolls report next month coupled with another weakening CPI release, and the Fed may find itself needing to start justifying its current policy stance. With the current battle against inflation also being accompanied by a credibility rebuilding exercise, the Fed needs to make sure it does not get things so wrong again, but this time in the opposite direction.