Quality Spreads

While the yield curve is widely followed and recognized as a leading indicator of the economy, another interest rate measure–quality spreads — is not as widely recognized as a leading indicator of the economy.

Maybe that is because it is not quite as reliable as the yield spread and has also given false recession signals. However, quality spreads do move in lockstep with another widely used measure of economic strength, industrial capacity utilization.

Capacity utilization was unchanged last month as manufacturing capacity utilization fell from 71.7 to 71.4 while capacity utilization in mining rose from 85.8 to 86.1 and in utilities it rose from 80.2 to 82.3. Also note that industrial capacity was unchanged last month while it has fallen -0.5% over the past 12 months. Do not read the fact that industrial capacity was unchanged as a signal that the decline in actual capacity is ending. With a 0.5% annual rate of decline it shows up in the capacity index falling one month and being unchanged the next month. This was just an unchanged month.

Total industrial output only rose 0.1% last month after rising 8.2% over the past year. The small gains consisted of a -0.4% drop in manufacturing output while mining and utilities production rose 0.4% and 2.7%, respectively. Essentially the only sector to experience solid gains was energy as even semiconductor output fell 0.2%.

Quality spreads imply that this is just the first of multiple weak industrial production reports.
The normal cyclical pattern is for industrial production to rise strongly in the recovery phase of the cycle until the prior peak has been surpassed. But it is now starting to look like output growth is flattening out well short of the previous peak.