JUNE Industrial production video

The May industrial production numbers show the impact of rising interest rates on activity in the sector, says KPMG Senior Economist Tim Mahedy as he breaks down the key takeaways from the latest data release.

Tim Mahedy

Tim Mahedy

Senior Director, Office of the Chief Economist, KPMG LLP

+1 415-963-5103

Video summary

Industrial production posts 0.2% gain in May. The May industrial production numbers show the impact of rising interest rates on activity in the sector, says KPMG Senior Economist Tim Mahedy as he breaks down the key takeaways from the latest data release.  


May Industrial Production: For now, there’s still some punch left in the bowl

Manufacturing production is starting to be impacted by rising interest rates, according to the May Industrial Production release. Although 2022 had the strongest start of any year since the early 1970s, the month-by-month pace of growth in industrial production slowed to only a 0.2 percent increase in May, which was below the market expectation of 0.4 percent. Activity in the manufacturing sector was dampened even more, with a contraction of 0.1 percent, well below the expected market increase of 0.3 percent.

This falloff should not be interpreted as a warning sign that the sector is on shaky footing. Consider that from January 2017 to February 2020, the average monthly pace of growth was 0.06 percent in the headline index and -0.02 percent in manufacturing.

Industrial production activity closely tied to interest rates

Instead, these developments are a result of the expected decrease in demand for durable goods stemming from the rapid increase in interest rates. Recent research supports our belief that, as we look forward, overall demand for manufactured goods will remain solid and activity will continue to expand over the next couple of months, albeit at a pace similar to May.

Taking a longer view, the Fed is likely to raise rates well above 2.5 percent by the end of the year, causing a sharp rise in capital costs. This would slow economy-wide investment and further discourage consumers from purchasing durable goods.  If these eventualities come to pass, the manufacturing sector could experience some weakness during the last third of 2022.  

Interest-rate-sensitive sectors show the most weakness

May’s decline in manufacturing activity can be broken down into a 0.2 percent contraction in durable-goods manufacturing and a 0.1% increase in nondurable manufacturing. Among durable goods, those associated with construction—wood products, electrical equipment and appliances, and machinery—all posted significant declines. A slowing in both construction and durable goods was expected, as they are among the most interest-rate-sensitive sectors of the U.S. economy. The anticipated increases to the federal funds rate is likely to continue impact all these sectors going forward.

Demand is cooling, but not falling off a cliff

While the May report showed a sharp slowdown in activity, other recent manufacturing surveys indicate that demand for manufactured goods remains solid. The ISM manufacturing index of new orders picked up in May, as did new orders in the New York Fed’s June Empire State manufacturing survey. Both sets of research suggest that activity should continue to expand over the next couple of months, even if the federal funds rate increases by 0.75bps as expected at the July meeting.

Three key takeaways

1.  The pace of growth in Industrial activity eased despite the robust start to the year, and we expect the relatively slower pace of growth to persist in the coming months.

2.  The most interest-rate-sensitive sectors are seeing the sharpest declines, and the Fed’s recent indication that the federal funds rate could hit 3.5 percent by yearend suggests these sectors are likely to see additional weakness.

3.  For now, demand is holding up, and there is still time for inflation to come down over the summer, which would likely slow the pace of interest rate increases in the fall.