Looming US Recession-like Conditions Warrant Interest Rate Caution

The recent path of US industry capacity utilisation summarises a great deal about the state of the US economy and background financial market conditions. Whenever capacity utilisation has been at the level recorded in March over the past 50 years, the US economy has suffered a recession. The current capacity utilisation rate implies already significant and growing excess capacity. It offers a partial explanation for the absence of wage cost pressures. It suggests inflation is unlikely to trouble policymakers. The falling capacity utilisation rate coincides with the rise in the US dollar and a leg down in commodity prices beginning in July 2014. Low utilisation rates reflect a resulting loss of US industry competitiveness. A consequential corporate earnings decline has contributed to the headwinds experienced by equity markets. At any other time in history, if capacity utilisation had been at its recently recorded level, there would have been pressure on the Federal Reserve to reduce interest rates. Other than the strong desire to ‘normalise’ rates to allow future policy flexibility, the argument to tighten policy presently seems dangerously flimsy.