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August 14, 2018 02:00 AM

Plastics production slips for fourth straight month

Bill Wood
Economics Editor
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    Federal Reserve Board
    The Federal Reserve Board reported that plastics production in the U.S. dropped during June.

    By almost any measure, the U.S. economy posted a strong performance in the second quarter. Aggregate demand, corporate profits and employment levels were all robust. Confidence levels, as measured both by survey data and the price levels of the equity markets, remained elevated. Inflation and interest rates were low, and real GDP expanded at a rate that was well above the long-term trend.

    It is hard for me to think of better macroeconomic conditions for U.S. businesses, and that includes plastics processors.

    So imagine my surprise when I updated my spreadsheets with the latest data from the Federal Reserve Board that measures activity levels in the plastics industry. According to the Fed, the index for industrial production of plastics products in June was 111.2. This marked the fourth consecutive monthly decline, and the figure for June was 1 percent lower than it was in June of last year.

    The June decrease pushed the total for the entire second quarter below the same period last year. And, as the chart illustrates, the slope of this recent downtrend appears to be steepening.

    The capacity utilization chart is even more surprising. The rate was steady through the second half of last year and the first quarter of this year. The fact that production levels were rising while the utilization rate was flat is due to investment in new machinery, which has made the industry more productive.

    This is great when demand is rising because it makes processors more profitable. But when demand slows, it pushes the capacity utilization rate lower. That's what has happened this year. Based on the current data and the fact we saw a strong upturn in the second half of last year, I have lowered my expectations for year-over-year comparisons for total output of plastics products in the second half of this year. I now expect the growth rates for both the third and fourth quarters of 2018 to be negative.

    If this forecast holds true, it will result in a negative annual growth rate for this year. This would be the first time since 2009 that the total U.S. output of plastics products failed to achieve positive annual growth.

    Jessica Jordan

    Now, don't get me wrong. I am not talking about the start of a real cyclical recession. Overall activity levels for processors under this scenario will still be pretty good, so this feels more like it will be a relatively short period of consolidation rather than a longer cyclical phase of contraction.

    But I am still having trouble reconciling this divergence in the trends for the macroeconomy and the plastics industry. Total new orders for durable goods — a good indicator for the manufacturing sector, including plastics — jumped 7 percent in the second quarter. Total retail sales — a good indicator of demand for all types of consumer goods, especially packaging — were up 6 percent.

    Given the trends in these indicators, my experience tells me that my original forecast for growth of 3-4 percent in the total output of plastics products and a steady rise in the industry's capacity utilization rate this year would be conservative. I would most certainly not have imagined that the growth rate would turn negative.

    Predictions are never easy. And at this moment in time, the data say my forecasts need some adjustment. So rather than argue with the veracity of the data — I offer no excuses and I have vowed not to yell "fake news" until I have more evidence — I will present some reasons that could explain the decrease in the plastics data so far this year.

    The likely reason is activity levels in some of the major end markets for plastics products are slowing. For example, demand for new motor vehicles is down. Total motor vehicle assemblies are about 2 percent lower for the year to date than they were in the first half of 2017. In addition, growth in spending for residential construction projects is slowing. Total housing starts declined by 5 percent in June when compared with last year. The effects of this can be seen in the data for pipe and siding demand in recent months and also in the data for appliance production, which was down 2 percent in the second quarter. Finally, U.S. production of medical supplies is down 4 percent year to date.

    These trends should improve moderately in the coming 12-18 months as wages gradually accelerate, household incomes rise and consumers fully realize the benefits of tax reform. But for now, I must accept my limitations as a prognosticator and lower the forecast.

    There is one other factor that bears mentioning as a possible cause of the trend divergence, either now or in the future: the deselection and outright bans of some plastics products. I am not sure if it is starting to show up in the data yet, but it is certainly seeping into my consciousness. And though it is still too early for me to make a call on this, it reinforces again that we all have a never-ending need for more information in order to stay competitive in the incessantly adapting marketplace.

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