The trends in the recent data that measure the total output of the U.S. manufacturing sector indicate we will have to wait awhile longer before we begin the next cyclical recovery phase. This is also true for the trend in the data from the U.S. plastics industry.
On the chart, I have graphed the industrial production data for the manufacturing sector broken down into durable goods and nondurable goods. For the sake of comparison, I have also included a graph of the data from the plastics industry that gets reported as a subset of the nondurable goods data. The Federal Reserve Board compiles and reports this data every month.
This graph shows the overall output of manufactured goods has been flat, or flat-to-down in the case of the plastics industry, for more than a year. The trend in the plastics data started to decline in late 2022, right around the time the Fed started raising interest rates, and the other two lines have not fared much better during that time.
These trends correspond to the patterns in consumer spending since the end of the pandemic. Data on consumer spending is reported every quarter by the Bureau of Economic Analysis as part of the GDP report, and the data from the first quarter is quite illuminating.
Overall, growth in consumer spending in the U.S. decelerated noticeably in the first quarter when compared with the fourth quarter of 2023. After adjusting for inflation, total personal consumption expenditures, or PCE, expanded by 2.5 percent in the first quarter. This follows a rise of 3.3 percent in the previous quarter.
The deceleration in spending should come as no surprise because that is what the Fed intended to do when it hiked the interest rates. It wanted to slow the economy and get inflation under control.
But a closer look at this data shows all of the growth in consumer spending in the first quarter came from the services sector. Spending on goods actually declined in Q1. Specifically, inflation-adjusted spending for services increased by 4 percent while spending for goods fell by 0.4 percent.
Breaking the data down a bit further, spending for nondurable goods (groceries, gasoline and clothing) was flat when compared with the previous quarter while spending on durable goods (motor vehicles, appliances and recreational goods) declined by 1.2 percent. Spending on motor vehicles and parts suffered the biggest decrease. It dropped by almost $14 billion on an annualized basis.
These recent patterns in consumer spending are a major reason behind the trends in the manufacturing data. From the Fed's perspective, the latest top-line GDP number indicates the U.S. economy is resilient and there is no reason to panic as far as recessionary fears are concerned. But from the perspective of U.S. manufacturers, consumer spending for goods is down.
In contrast, consumers are expanding their spending services. Specifically, they are spending on rent, utilities, insurance, financial services and health care. These are the major drivers of growth in the services sector. With the exception of health care, these service industries are not major end markets for plastics products. They also tend to be industries that are less susceptible to rising interest rates.
So, how does this affect the outlook for manufactured products, specifically plastics products?
The services sector is much larger than the goods sector in the U.S. economy, and when demand for services is this strong, it keeps upward pressure on prices.
As part of its release of the GDP data, BEA also reports a PCE Price Index. This is the preferred measure of inflation for the Fed. The price index data for Q1 shows prices for goods actually declined. The Fed's rate hikes have cooled demand for goods so much that prices came down in the first quarter. There is no inflation in the goods sector anymore.
In contrast, prices for services increased by more than 5 percent annualized in Q1. So, rising prices for services, which are the result of robust spending growth for services, are driving the overall rate of inflation.
Strong demand for services is why the overall rate of inflation actually accelerated in Q1. That is also why the Fed is stuck right now. It cannot lower interest rates, which is what the goods producing sector needs in order to begin the next recovery phase in the cycle.
With inflation actually moving away from the Fed's target level of 2 percent, it is unlikely it will lower interest rates anytime soon. Or, to put it another way, the Fed will not lower interest rates as long as the employment data stays robust. People have jobs, and households are spending money. Aggregate demand is rising — it is just not rising for the products that we manufacture in this country.
One bright spot for manufacturers in the first-quarter GDP data was in the category of investment in housing. Inflation-adjusted investment in housing jumped by almost 14 percent from the previous quarter. If a strong growth trend in personal investment for housing is maintained, then this will pull demand for many types of plastics products and durable goods up with it. The trend in investment in housing has been weak for the past few years, so this is a long-overdue increase. Let's hope it continues.
But right now, interest rates are not going anywhere. And if the recent uptrend in inflation continues, it is possible we could get a hike in interest rates. That is still a low probability at this point, but after the past three years, nothing will surprise me.
