The index of Industrial Production is a fixed-weight measure of the physical output of the nation's factories, mines, and utilities. Manufacturing production, the largest component of the total, can be accurately predicted using total manufacturing hours worked from the employment report. One of the bigger wildcards in this report is utility production, which can be quite volatile due to swings in the weather. Severe hot or cold spells can boost production as increased heating/cooling needs drive utility production up.
In addition to production, this monthly report also provides a measure of
capacity utilization. Though the rate of capacity utilization is seen as a
critical gauge of the slack available in the economy, the market does not
completely trust this measure. Capacity is very difficult to measure, and the
Fed essentially assumes that growth in capacity in any given year follows a
straight line. One can therefore predict the capacity utilization rate quite
accurately based on the assumption for production growth. The 85% mark is seen
as a key barrier over which inflationary pressures are generated, but given
revisions to these data and the difficulties with capacity measurement, the 85%
mark should be viewed cautiously. It would be appropriate to look for
corroborating inflation indications from commodity prices and vendor
deliveries.