Productivity Growth is the Key to 2019

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Source: Bloomberg and Voya Investment Management, 6/11/2018

Special Guest Blogger: Tim Kearney

The October employment report was solid up and down the line. The 250,000 headline number outperformed expectations by 50,000 – better than the -16,000 revision to September. Manufacturing payrolls outperformed by 16,000. Labor force participation was up 0.2%, holding above the 2016 lows – a long downdraft arrested. The most important data from last week was average hourly earnings (above 3% for the first time since 2009) and non-farm productivity (2.2% in the third quarter SAAR, 1.3% year-over-year). It is clear that there is a Phillips Curve, but it does not work in the way that many analysts think, from unemployment to inflation. Rather, the Phillips Curve relationship works thusly: tight labor markets drive wages with productivity growth as a constraint. How should we understand rising wages, then? It is the nexus of wage growth, inflation and productivity growth that explains if wages are expanding to such a degree that it can affect markets and the economy. Assuming that CPI growth held at 2.3% in October, the 3.1% average hourly earnings translate into a real wage increase of about 1%. However, the 4-quarter growth of productivity has lifted to 1.3% from zero in 2016. That is modest progress, but implies that unit labor cost growth should not be pressuring profit margins at this point.

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