As production turns…
The index of industrial production rose 0.4 percent in February after an upwardly revised gain of 0.2 percent in January. Economists were predicting a smaller gain for the month. While production remains 4.1 percent below year ago levels, there is no question that the trend has finally begun to improve. Both January's and February's gains are pretty meager compared with the sharp declines of the past year and a half, but the combination of increases we have seen in the ISM manufacturing index, the Philadelphia Fed's business outlook survey and factory orders are all pointing to the beginning of a recovery in production early this year.

All sectors of the economy are not benefiting equally from the production gains. For instance, among major market groups, production of consumer products has risen in three of the past four months, while business equipment has declined for two of the past four months. Construction supplies have declined in only one of the past four months.

Much of the high tech sector is on the rebound. Computers and office equipment as well as semiconductors and related electronic components have posted healthy gains. In contrast, communications equipment eked out a 0.1 percent rise in February after pretty hefty declines in the past few months, even as the other high tech industries were improving.

On the whole, production of consumer goods is on the mend, but capital equipment is not showing the same trend. This confirms what Alan Greenspan and other Fed officials have noted in speeches over the past several weeks: consumer spending is on the road to recovery but risks remain with respect to capital spending.

Retail sales inch higher
Retail sales rose 0.3 percent in February, offsetting the January rise entirely. Excluding the volatile auto sector, sales inched up 0.2 percent after surging 1.2 percent in the previous month. Durable goods generally outpaced nondurable goods. For instance, spending at furniture & home furnishing stores jumped 1.5 percent in February after several months of increases. Spending at electronics & appliance stores jumped 1.1 percent, the third increase in four months. Yet many of the stores that primarily sell nondurable goods were more sluggish in February.

While the retail sales figures were somewhat disappointing to equity investors when they were reported this week, the overall trend in retail sales is rising. Sales are skewed to some extent because of the auto incentives offered in the fourth quarter. But the pattern of retail spending is consistent with a recovery. After all, we haven't had a long or deep recession where consumers had to rein in spending. Thus, pent up demand is not all that robust right now. Going forward, retail sales are likely to post moderate gains. The early reading on the University of Michigan's consumer sentiment index jumped to 95 in mid-March from a level of 90.7 in February.

Moreover, some economists believe that the rise in retail inventories for the month of January suggests that retailers see more activity and want to restock their shelves. Auto inventories surged 3.3 percent in January, but non-auto retail inventories gained a moderate 0.6 percent for the month. Usually, inventories are a lagging indicator of activity. Sometimes it is difficult to tell whether inventories are rising intentionally or not. But it is certainly possible that retailers would like to replenish shelves in light of the fact that non-auto retail sales jumped 1.2 percent during the same month. Retail inventories (and the inventory-to-sales ratio) remain well below year ago levels.

What inflation?
The producer price index edged up 0.2 percent in February after a meager 0.1 percent rise in the previous month. Energy prices rose only 0.4 percent but food prices jumped 1 percent for the month. Excluding the volatile food and energy components, the PPI was unchanged in February after edging down 0.1 percent in January. On the whole inflation remains subdued. A whopping 20.4 percent drop in energy prices over the year has helped dampen the total PPI. Consequently, the PPI is down 2.6 percent from year ago levels. But even after taking the volatile component into account, the core PPI is up only 0.5 percent from a year ago.

Apart from a 1.5 percent spurt in nonenergy, nonfood crude goods prices, inflation is not in the pipeline. Intermediate goods prices (nonfood, nonenergy) were flat for the second straight month and are now down 1.8 percent from a year ago.

The overall inflation picture bodes well for the economy. While it is true that the Fed may want to start raising rates within the next couple of months in order to get closer to a "neutral" stance at some point this year, a low inflation environment helps to curtail interest rate hikes. Former Fed governor Meyer has noted that a 4 percent federal funds rate target would get the Fed within a neutral zone. But inflation in the goods market is now negative, so it would be tougher for the Fed to raise rates very rapidly within this year. Certainly, they want to be pre-emptive but the lack of inflationary pressures should limit their rate hikes in 2002.