Economic Tour, Continued: Inflation, Supply Chain, and Industrial Production

Lately the economy has been akin to weather in the Midwest. If you don’t like it, just wait 10 minutes and it will change. It has long been asserted that the only function of economic forecasting is to make astrology look respectable. That’s rarely been as true as it is right now. There have been constant questions regarding the status of tariffs, geopolitical storms that have engulfed the oil market, and trade wars that have set longtime allies at one another’s throats. In the face of this, can anything be said that is close to definitive? Sort of. Different scenarios—good, bad, and ugly—might play out depending on how these global issues shake out in the next quarter or two.

Inflation. If there is one overarching concern among most economists, it is the status of inflation. That issue will have a profound impact on just about everything: Fed policy, consumer confidence, even the politics of the midterms. The economists will fret over all manner of data releases and indicators, but the average consumer essentially cares about two things: inflation rates and employment. One needs a good job that has security and pays well enough to support a chosen lifestyle, but that is not enough if inflation is moving that purchasing target constantly.

The Fed looks at the Personal Consumption Expenditures (PCE) index and, specifically, the 12-month PCE, because it is precisely what the consumer is buying and how much it costs. The PCE is more accurate than measures such as the Consumer Price Index or Producer Price Index. The problem with PCE data is that it takes a while to collect. Right now, the Fed is working with the numbers released at the end of February. That means the Fed knows that inflation likely increased in March and April, but it doesn’t know the precise percentage. The last set of readings have it around 2.4%, but estimates are that it may be as high as 3.4% by now.

Some aspects of inflation deserve more attention than they are often given. It is important to understand the roots of inflation. In more cases than not, inflation is a disease of growth. It happens when demand exceeds supply, and that occurs in many circumstances.

Some kind of crisis (like the oil situation now) can create an outright shortage. In most cases, though, inflation occurs when the consumer wants more than the supplier can provide, and the system is somewhat incapable of autocorrecting. Higher prices discourage some people from wanting the item, but higher prices also provide an incentive to produce more to meet that demand.

The current inflation is mostly due to supply constraints, but not entirely. Wage pressures are increasing, as there are too few qualified people, and those who have the skills are in a position to demand higher wages. There has been a steady decline in the core rate of inflation. This is the rate derived without looking at the volatile categories of food and fuel. As these prices tend to change on an almost hourly basis, making comparisons is very difficult.

Supply Chain. The supply chain stress indicators had been calming down as the big issues of the last couple of years faded. The Panama Canal is open again at full capacity, and there has been movement through the Red Sea and Suez Canal (until very recently). Port congestion was down. All seemed on track—and then the Iran war started.

This time, the bulk of the ship traffic is based on oil and other commodities, so it has not had the same impact as when the Chinese ports were in trouble. The supply chain crisis has not reappeared for most goods, but the political factors stemming from the tariffs remain an ongoing concern.

The crisis in the Strait of Hormuz has not dealt the supply chain the same kind of blow as the previous crises, but for commodities and oil, the situation has been worse. The longer this lasts, the more the general impact will be.

Interest Rates. Only a few weeks ago, the consensus view was that the Fed was close to a rate cut of at least a quarter point, but that was before the oil crisis blew up and the price per barrel soared into the hundreds. Since then, the markets have been all over the place as the traders react to every rumor and innuendo that comes from a dozen world leaders.

The Fed decided to stand pat, and that has been the pattern for many other central banks. Everyone is waiting for some signal of oil stability before committing to some position on inflation. The Fed is well aware that the economy could use a shot in the arm, but it also knows that there has been growth this quarter, and that suggests the need is not urgent.

A rate adjustment generally takes a year to 18 months to work through the economy, so the Fed is trying to forecast what the growth needs will be in Q4 and into 2027. The best guess right now is that rates will remain stable until perhaps mid-summer, unless the oil crisis extends deeper into the year.

Unemployment. The jobless numbers have remained stable, more so than had been anticipated. The last jobs report showed a surprising gain driven almost entirely by the health care sector. The health care community lost thousands of nurses, technicians, doctors, and others to burnout during the pandemic. At the same time, baby boomers are driving demand for health care aggressively.

Although there have been layoffs attributed to AI and technology, the demand for labor in manufacturing, construction, and transportation has been high as many boomers have retired. And as some 22 million more retire over the next few years, only about 2.5 million new entrants are expected. The real issue is that 7.2 million people are seeking jobs, but they lack the skills needed and are thus categorized as “discouraged workers.” The overall rate of unemployment has remained at around 4.4%, but the U-6 rate is nearly twice that.

Commodities. The entire commodity market has been reacting to many of the same motivators and factors. Demand in general has been improving as manufacturing and construction have both performed better than expected. This growth may be in jeopardy, however, and that gives the suppliers some pause. The added wrinkles of shifting tariff pressure and short-term outlooks have dominated the sector.

As the Trump administration navigates the tariff situation after the Supreme Court ruled the use of IEEPA illegal, it’s now relying on other provisions. Some of these (on steel and aluminum) are based on tried-and-true provisions, and they will be swiftly enacted.

The crucial question is supply. Will there be enough flexibility in pricing to encourage producers to meet the projected demand? The oil markets are a commodity nightmare all their own, as the issue is not supply. There is way more oil available than is needed. The worry a few months ago was about an oil glut; now, theconcern is transportation related.

Industrial Production. Industrial production decreased by 0.5% in March after increases of 0.2% in February and 0.7% in January. This was not necessarily expected. The gains were welcome and reinforced the perception of a stronger manufacturing sector. There was 2.4% growth for the quarter as a whole.

In February, manufacturing output dipped by 0.1%, the index for mining dipped by 1.2%, and utilities output moved down 2.6%. Total industrial production was 0.7% above its year-earlier level. Capacity utilization remained unchanged at 75.7%, a rate that is 3.7% points below its long-run (1972–2025) average. Capacity utilization is ideally between 80% and 85% but has not been in that range for years. There is still some undercapacity, and that limits expansion and hiring. All in all, the industrial production numbers deteriorated a bit but have thus far avoided crisis status.

What Does This Mean for Manufacturers? You know that adage about a glass half full or half empty? That sums up the situation now, as some sectors are doing well and others are struggling. Data has been showing solid growth in machinery, aerospace, and even fabricated metal in general. Automotive is not doing all that well, but electronics has continued to surge. The real looming threat is the supply chain. Another few weeks of the Iran war will severely affect oil as well as many other commodities.