US economic growth is strong, a clear positive for the stock market. But, a look behind the numbers suggests it is not entirely bad for Treasuries either. Both statements can be supported because a striking feature of the past two quarters of strong GDP gains is a pickup in productivity growth. This feature bodes well for corporate profits -- a positive for stocks. It also keeps price inflation low as nominal wage gains are offset by productivity growth and thus are not inflationary -- a positive for Treasuries. Longer-term yields are likely to stay in a range as the stock market rallies. The resulting improvement in real wages from higher productivity growth lifts workers' standard of living to boot.
Nonfarm Business Productivity has been strong in the past two quarters, rising 1.5% (q/q, saar) in Q217 and 3.0% in Q317. They account for much of the 3.8-3.9% gains in Nonfarm Business Output in these quarters. Together, they are among the strongest two-quarter consecutive gains in productivity outside of the rebounds typically seen after the end of a recession. The expansion of the internet, particularly in the retail space, may help explain the strength of productivity. The retail sector certainly has become more efficient as a result of on-line buying and centralized warehousing. Also, the rebound in domestic oil production is likely a high-productivity industry and helped boost overall productivity growth in the past two quarters as output responded to higher oil prices.
Productivity's strength dampens the inflationary implications of higher wage growth. Thanks to the strength of productivity, Unit Labor Costs
(Compensation/Hour divided by Productivity) remained negligible in
Q317. To be sure, it's not clear that wage inflation is picking up. While Compensation/Hour -- the broadest measure of labor costs -- sped up in Q317, the speedup may be just an offset to the slowdown in Q217. A similar pattern is seen in the Employment Cost Index -- the labor cost measure least affected by composition shifts between low- and high-paid workers. In both cases, the y/y was little changed in Q317. Average Hourly Earnings shows some sign of speedup, but were impacted by the hurricanes (positively) in Q317 and then negatively in October. It remains to be seen if its trend has moved up.
(q/q percent change, saar) (y/y percent change)
ECI Comp/Hr AHE ULC ECI Comp/Hr AHE ULC
Q117 3.2 4.9 2.4 4.8 2.4 1.9 2.7 0.7
Q217 2.0 1.8 2.6 0.3 2.4 1.1 2.6 -0.2
Q317 2.8 3.5 3.0 0.5 2.5 1.4 2.7 -0.1
Oct17 2.4
The economy's current strength is not likely to persuade the Fed to be more aggressive than its stated plan to tighten monetary policy gradually, although the latter likely includes a December rate hike. Last week's November FOMC Statement downplayed the significance of current GDP strength, attributing post-hurricane rebuilding as a reason to expect a temporary jump in growth. (The Atlanta and NY Feds' models now project 3.2-3.3% for Q417 Real GDP growth.) But, the Statement also continued to emphasize that "the Committee is monitoring inflation developments closely." The markets' near-100% probability of a December rate hike might fall if the October Core CPI (due November 15) comes in low. And, if productivity growth remains high into Q417, a low Core CPI may be a good bet.
From a longer perspective, the Fed's estimate of longer-term non-inflationary trend Real GDP Growth would need to be raised from 1.8-2.0% if the recent pickup in productivity growth turns out to be the start of a ratcheting up of trend productivity. The Fed's longer-term projections of the funds rate and longer-term Treasury yields probably would be raised, as well. A pickup in trend productivity growth also would prompt the Congressional Budget Office to lower its longer-term projections of the federal deficit, social security/medicare deficit, etc.
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