Latest Fed Data: A Worrisome Case of Deja-vu?

The latest readings on statistics published this week by the Federal Reserve suggest that the outlook for the U.S. economy remains bright. However, if you compare them side-by-side, the two series paint a picture that is seemingly at odds with conventional interpretations.

More specifically, the year-on-year trend of industrial production -- a gauge of the nation's output of computers, appliances, automobiles, and industrial machinery -- has rebounded from its 2009 lows at a far faster pace than capacity utilization, which measures how much of America's productive capacity is being put to good use.

Is this significant? Well, the last two times we saw disparities as large as we have now was in the spring of 1976 and in late-1983. As the following chart suggests, both occasions marked an interim peak in the year-on-year trend of real (inflation-adjusted) gross domestic product.

To be sure, the apparent relationship between these statistics may be no more than a coincidence, and the number of relevant data points is very small.

That said, the argument makes sense on an intuitive basis. If the overall amount of slack in the economy remains fairly large, as other evidence suggests is the case, then excess capacity will act as a drag on growth at the first signs of upward momentum. Businesses that had "mothballed" facilities during the downturn, for instance, might bring them back on line to capitalize on improving conditions. The net result would be increased production but limited economic growth.

In many respects, the situation is akin to the current housing market, where any nascent recovery is likely to be stopped dead in its tracks because higher prices and increased turnover will lure large amounts of "shadow inventory" back into the marketplace.

Under the circumstances, today's cheery market reaction to ostensibly stong economic data might be somewhat unwarranted.