Is A Growth/InflationTrade-Off Right?

The stock market should get relief from this week's July CPI Report, which could print below the already low consensus estimate.  But, it may not be enough to preclude another 25 BP Fed rate hike at the September 19-20 FOMC Meeting.  Friday's July Employment Report kept open this risk, although it argued against a more aggressive policy tightening.   Nonetheless, there is a way to interpret the jobs data in a favorable way regarding the inflation outlook that could hold back the Fed at some point.

Consensus looks for +0.2% m/m in both Total and Core CPI.   This would be close to the Fed's annualized 2.0% target for the second month in a row.  Moreover, a 0.1% print for both can't be ruled out.  Owner's Equivalent Rent needs to rise no more than 0.5% (as in June), used car prices and airfares fall, and hotel rates flatten out.  For a below-consensus Total, food at home prices need to fall, as well, which is suggested by recent softness in PPI food prices.  

Whether a low CPI is enough to persuade the Fed to hike once and pause or to pause in September could depend on its view of the labor market.  Friday's Report showed the latter to be still tight, with the Unemployment Rate slipping to 3.5% and wage inflation remaining high at 0.4% m/m.  It keeps open the door for a September hike.  However, the latter is still not a foregone conclusion, since the Fed will see the August Employment Report before the September meeting.  And, the BLS will release its estimate of the Benchmark Revision to Payrolls on August 23 -- possibly revising down the trend in job growth.

In any case, there may be a way to interpret the latest data to draw a more positive view of the inflation outlook.  More than half of the Payroll gain was in Health, Education and Government.  While their demand for workers helps to keep wage inflation high, other sectors look like they are trying to economize on high-cost labor by cutting jobs and the workweek.  These efforts should help offset higher wage rates and hold down prices.  And, they may not reduce output if offset by higher productivity of the retained workers.  

Last week's Q223 Productivity Report was encouraging in this regard.  The 4-quarter trend in Productivity is now 1.3%, up from -0.2% over 2021-202 and close to the pre-pandemic pace (1.6% over 2017-19).  With the latest Atlanta Fed model's estimate of Q323 Real GDP Growth at 3.9% (q/q, saar) and July Total Hours Worked only 0.3% (annualized) above the Q223 average, another strong increase in productivity seems possible in Q323. 

Strong Productivity offsets the impact of fast wage growth on price inflation.  Unit Labor Costs  (Compensation Growth Less Productivity Growth) averaged only 0.9% (q/q, saar) over the past 3 quarters.  It may be one reason why core inflation could be slowing.  The large wage increases could be viewed as labor capturing part of the productivity gain and not requiring a pass-through to prices.  In this view, the Fed could tolerate the high pace of wage increases and pause in its tightening.