Caution Ahead, But A Positive Macroeconomic Shift?

The stock market could trade cautiously this week as it faces the likelihood of a high January PCE Deflator and the start of a new set of monthly data.  However, last week's surge on Nvidia's earnings report underscores a potential macroeconomic shift that could be a big positive for stocks -- a ratcheting up in the productivity trend.  It would not only boost profits, but allow for higher real wages and lower inflation. 

Besides the potential for AI to lift productivity, the spate of corporate layoff announcements suggests that companies already have begun improving efficiency.  After being overly aggressive hiring after the pandemic, many corporations appear to be focusing on cutting costs.  This is another way of saying they are boosting productivity.  From a macroeconomic perspective, eliminating jobs boosts the pool of available workers, relieving pressure in the labor market.  In particular, it allows for a shift of workers toward areas favored by the Administration, such as alternative energy, EVs, re-shored businesses, etc., without putting large upward pressure on wages. 

Cost-cutting could be a factor behind the speedup in productivity growth last year.  Nonfarm Productivity rose 2.7% over the four quarters of 2023, much better than the -2.0% over 2022 and the +1.0% long-run trend assumed by the Fed.  The higher productivity growth explains how 2023 Real GDP Growth could substantially exceed the Fed's estimated long-run trend of economic growth without pushing down the Unemployment Rate significantly.  The question is whether the higher productivity pace will continue.

It is likely too soon for the Fed to raise its estimate of long-run Real GDP Growth from 1.7-2.0%, as it probably needs to see more evidence of persistently high productivity.  But whether the Fed raises it long-run GDP estimate is something to look for in the revised Central Tendency Forecasts released at the March 19-20 FOMC Meeting.   An upward revision would offset the inflationary implications of higher estimates for 2024 Real GDP Growth, which are likely given the strong start to the year.  The Fed can cite a productivity-led improvement in trend-growth as a reason to cut rates despite stronger economic growth than had been assumed earlier.

The consensus estimate of the January PCE Deflator (+0.3% m/m Total, +0.4% Core) reflects the same start-of-year price hikes seen in the CPI.  Indeed, the risk is that the Deflator may print higher than the consensus estimate.  While there may be knee-jerk selling on the print, it would be an overreaction, since these price hikes are not likely to persist.  Consensus also looks for an uptick in the Mfg ISM to 49.5 in February from 49.1 in January.  Stronger economic data should be less of a problem for the markets if higher productivity is helping to achieve this strength.