This is the most disappointing chart in the US economy, via Deutsche Bank’s Torsten Sløk.
What we’re looking at here is an economy that appeared close to reaching “full capacity” and “full employment” before drifting away from those milestones.
A few months ago, capacity utilization was edging back towards levels not seen since before the financial crisis. This matters because before the financial crisis, we had inflation running above the Fed’s current 2% target. Right now, inflation is nowhere to be found.
The reason inflation ticks up when we’re at something like “full capacity” — which in the last cycle was around 80% — is because at a certain point you can no longer ramp up production. As the unemployment rate falls and the economy heals, you can keep prices relatively stable while bringing production back towards full capacity.
But if you’re making, say, all of the cans of soda your factory can handle, your only response to an increase in demand — which is presumably created by more people having money to spend as the unemployment rate falls — is to increase prices. And thus, inflation.
This is basically the Phillips curve. Now while Sløk asks if the strong US dollar isn’t to blame for this weakness (with a strong dollar hurting exports), certainly the story changed a bit.
Moreover, a few months ago the unemployment rate was right up against the Fed’s NAIRU target, or the point at which it expects inflation to accelerate.
Then in March the Fed lowered its NAIRU target from 5.3% to 5.1%, and the unemployment rate has not yet moved back towards that level, which economists would consider “full employment.” Ahead of Friday’s jobs report, the unemployment rate sits at 5.4% and expectations are for it to remain there.
And so while the Fed has made fairly clear it wants to raise interest rates in 2015, without inflation showing signs of turning higher or a labour market looking poised to hit “full employment” or a manufacturing sector hitting “full capacity.”
A few months ago, the economy looked like it was coming right up to the edge of breaking out. Now? Not as much. By this measure, at least.