When Federal Reserve policymakers hit the "pause" button on rate hikes at their Aug. 8 meeting, they were undoubtedly hoping subsequent data would show inflation held mostly in check. They must not have liked the Sept. 6 release of the second-quarter productivity report.
The headline nonfarm productivity figure held some good news, as it was revised higher in the second quarter to a 1.6% growth rate from the initially reported 1.1%. Unfortunately for Ben Bernanke & Co., unit labor costs also were revised higher, to 4.9% from the original 4.2% rate. The report's revised figure for labor costs in the first quarter was an even more astonishing 9%.
The revisions dramatically raised the growth trajectory for U.S. unit labor cost growth. Upward hourly compensation revisions had been signaled by the last second-quarter gross domestic product report, though the boosts proved much larger than most economists cautiously assumed. The outsize back-to-back quarterly gains in unit labor costs will plague the year-over-year calculations for the next two quarters.
BETTER PRODUCTIVITY AHEAD. The specifics for the compensation data in this productivity report were ugly for the Fed, despite the higher productivity growth path. Hourly compensation was revised in the first quarter from a 6.9% growth pace to a lofty 13.7%, while the second-quarter gain was boosted from 5.4% to 6.6%.
Looking ahead, the employment figures for the third quarter suggest a moderation in hours worked to the 1.2% area, which should leave a solid 2.3% third-quarter productivity gain. This should allow quarterly unit labor cost growth to drop back to the 2.5%-3% area during the quarter.
But this better productivity performance should still leave year-over-year unit labor cost growth at a troublesome 5%, given the huge gains registered in the last two quarters. The same should hold true for the fourth quarter, when a 3%-3.5% unit labor cost gain would again leave 5% year-over-year growth.
AMMO FOR INFLATION HAWKS. These figures, combined with the solid uptrend in year-over-year wage growth from the monthly employment reports, will keep the Fed in an uncomfortable position regarding the inflation outlook—despite the growing optimism expressed in the last Federal Open Market Committee (FOMC) statement that "inflation pressures seem likely to moderate."
As we noted at the time, this word choice by the FOMC for the policy statement was risky, because it banked on some moderation in upcoming inflation reports, even though this forecast remains, to some degree, conjectural. We do expect headline inflation to moderate over the coming months as energy prices ease back, but it is unclear what the pattern will be in the core and wage statistics.
Though we still expect the Fed to sustain its pause at the September FOMC meeting, the labor-cost trajectory implied by this set of productivity data will keep hawks on the committee on the offensive. There is no relief in sight for the Fed if we are to monitor all the available inflation measures, though the drop-back in energy prices as we enter September is working in the Fed's favor.