Production drop invites recession talk
The index of industrial production fell 0.2 percent in November after inching down 0.1 percent in October. The index hasn't posted a one-two punch like this since the summer of 1998 when production suffered from a strike at GM. Auto assemblies have dropped sharply in the past two months, but not because of labor disputes. Rather, mounting inventories coupled with declining sales forced automakers to trim production schedules. The chart below points to a rather sharp deceleration in production in the second half of the year.

The industrial production index was actually held up by a surge in utilities in November. Production in manufacturing fell 0.5 percent during the month after remaining unchanged in October. The chart below shows the yearly change in manufacturing versus the yearly change in the nation's growth sector -- computers, communications equipment and semiconductors. This component continues to be the impetus behind growth even though it is beginning to show slight signs of moderation. Nevertheless, it is up a whopping 55.6 percent relative to year ago levels. But clearly, computers alone can't hold up the manufacturing sector.

The decline in production shouldn't be too much of a surprise. Business inventories grew 0.6 percent in October with particularly large gains at manufacturers and retailers. The run-up in inventory building that began in May 1999 was initially due to increased demand for goods. Notice that the inventory-to-sales ratio was then still falling. The ratio started to turn higher in May 2000. The rising ratio coupled with accelerating inventory growth suggests that retailers and manufacturers did not intend some of the gain. While the ratio remains low by historical standards, the upward trend does signal the need to scale back on production.

The sharp falloff in production activity is leading many economists to start talking about a recession. Most are distinguishing between an outright recession when real GDP actually declines for two straight quarters, and a "growth recession" when the rate of GDP growth moderates to such low levels that it may feel like a recession. In the past, a sharp deterioration in the manufacturing sector has without question led to recessions. In today's economy where services hold a disproportionate share, a decline in manufacturing activity need not lead to outright recession. But no doubt about it, this set of economic indicators sets the stage for weak growth in either the fourth quarter of 2000 or the first quarter of 2001.

Soggy retail sales
Retail sales fell 0.4 percent in November after remaining unchanged in the previous month. The two-month pace was depressed by declining auto sales. Excluding autos, sales rose 0.2 percent November, trending lower from the September and October pace. The chart below points to the weak pace that began in the second half of this year.

Auto sales have come down from their unprecedented heights, but sales of durable goods in general are moderating. The chart below depicts yearly changes in durable and nondurable goods. Sales of nondurable goods have certainly softened in the past few months, but durable goods sales have fallen off a cliff. Sales at nondurable goods stores are held up by rising oil prices (gas station sales). But nondurable goods tend to perform better in questionable economic times.

The retail sales data certainly supports the production figures, which are indicating some deterioration in the economic climate. The combined figures will go a long way in allowing Federal Reserve officials to lay down their guard and shift the policy bias towards neutral at next week's FOMC meeting.

Inflation could take second billing to economy
The consumer price index rose 0.2 percent in November, matching the October rise. Energy prices inched up a mere 0.1 percent while food prices were unchanged for the month. Excluding food and energy, the CPI rose 0.3 percent, higher than last month but matching the September gain. This momentary heart stopper was due to that old nemesis, tobacco prices, which surged 3.6 percent. Otherwise, price increases were generally subdued. Medical care costs edged up 0.2 percent, the smallest monthly rise in 13 months. Apparel prices declined 0.4 percent, the first drop in four months. On a year over year basis, the total CPI remained edged down to 3.4 percent while the core CPI edged up to 2.6 percent.

The news was more favorable from the producer price index. The total PPI ticked up 0.1 percent in November while the core PPI remained unchanged for the month. Prices of consumer goods were generally subdued except for a 1.6 percent drop in drug prices. This sector tends to fluctuate like tobacco and cause distortions to monthly changes. Capital goods prices were flat for the third time in the past four months. In addition to the favorable finished goods index, prices of intermediate goods and crude materials declined. Prices of core components (excluding food and energy) fell also, not just the volatile sectors. This bodes well for the finished goods index in the next couple of months since there doesn't seem to be inflationary pressures in the pipeline.

The inflation news is on the whole favorable, although Fed officials would probably prefer to see a more decided downward trend in the consumer and producer price indexes. In any case, the inflation figures aren't scary enough to prevent the Fed to shift away from the inflation risk bias currently in place when they meet next week.