US industrial production fell by 0.1% in July, while analysts expected it to remain unchanged at 0.0%. However, June’s production was revised up from 0.3% to 0.4%. July’s capacity utilization hit the predicted 77.5%, and June was also adjusted slightly from 77.6% to 77.7%. On a yearly basis, industrial production grew by 1.4%, and capacity utilization rose by 1.5%.

Cooling US Economy

The small decline in July’s industrial production of -0.1% adds to concerns about a slowing US economy. This follows the July jobs report, which showed a moderate increase in payrolls of 160,000 and a core Consumer Price Index (CPI) that dropped to 2.9% year-over-year. For traders, these trends indicate that the Federal Reserve’s tight policies are starting to take effect. It’s important to examine the details of the report; the increase in June’s production to 0.4% is noteworthy. This suggests that the industrial sector is not in freefall, but rather experiencing a mild slowdown. This view of a “soft patch,” rather than a sharp downturn, complicates a purely negative outlook on the market. This information affects expectations for future interest rates, which are crucial for derivative pricing. The likelihood of a rate cut in the fourth quarter, originally at about 40% last week based on CME FedWatch data, may now rise to around 55-60% following this report. Positioning in interest rate futures or options on Treasury ETFs like TLT might be a good strategy to benefit from this shift. Given the uncertainty, we can expect an increase in market volatility in the coming weeks. The VIX, currently around a low 14, may gradually rise to the 18-20 range as the market processes mixed signals about growth. Buying VIX calls or using straddles on the SPX could be a smart way to prepare for this anticipated increase in market fluctuations.

Market Strategy

This weakness in industrial production signals a chance to hedge or take bearish positions on industrial companies. For instance, considering buying puts on the Industrial Select Sector SPDR Fund (XLI) might be worthwhile. On the flip side, a more dovish outlook from the Fed is generally good for growth stocks, especially in the tech-heavy QQQ. We’ve seen similar situations before, particularly leading up to the Fed’s policy shift in 2019. At that time, slowing manufacturing data preceded a series of rate cuts that ultimately boosted the market. This historical perspective suggests that while short-term caution on industrials is wise, this slowdown could pave the way for a significant market rally later this year if the Fed decides to act. Create your live VT Markets account and start trading now.

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