tenancy
Estimating the level of fixed credit costs
On the macroeconomic level, capacity utilization rates are a good indicator for the level of fixed costs of the corporate sector, because the higher the utilization rates are, the less the costs of maintaining the infrastructure to generate one unit of output will be. Furthermore, an increase in industrial output hints at rising revenues and solid cash flows for the companies. This strengthens the companies’ abilities to service their debt. Therefore, credit spreads tend to tighten when capacity utilization and industrial production increase. Yet, rising cash flows tend to invoke business investment, particularly when capacity utilization rates are above average. Historically, levels above 80–82 percent have been a threshold above which the willingness to invest has increased significantly. Like capacity utilization rates, industrial production is a coincident indicator for the state of the economy. Across the business cycle, credit spreads tighten when industrial production grows, and sell off when the economy is doing poorly. Usually, when the economy is doing well, default rates tend to fall and the more positive sentiment usually leads to a lower level of risk aversion. Therefore credit investors settle with lower spreads than in times of poor economic performance.
Low loans capacity utilization is good
Investors can also see low capacity utilization as good news since it means there is little near-term risk of demand getting ahead of supply, sparking inflation. And that means the Federal Reserve should not have to raise interest rates aggressively for quite some time. Large amounts of unused production capacity acts as a buffer that diminishes the inflation risks implicit to rising demand. The other clear sign of the high level of operating leverage in the US corporate sector is the jump in productivity.
Of course, for productivity increases and low capacity utilization to work through to corporate profits, business sales still need to pick up. Therefore, final demand has to increase. For the economy to really soar, businesses have to start spending on hiring workers, new technology and capital improvements. And usually will, once the evidence clearly shows that profits are perking up.