Despite milestones and market moves, last week was less than the sum of its parts

Brian Nick

The last week’s market highlights:

Each week, we present our featured topics in the context of the major themes listed below from Nuveens 2021 Midyear Outlook :
  • U.S. economy: The growth rate has peaked but will remain high throughout 2021.
  • Global economy: The economic recovery will spread to Europe and eventually Asia as more countries achieve herd immunity from COVID-19.
  • Policy watch: Policy is becoming marginally less accommodative as the recovery takes hold.
  • Fixed income: Even with rates subdued, credit-sensitive parts of the market should lead.
  • Equities: The best opportunities may now lie outside the U.S.
  • Asset allocation: Continue to allocate toward assets poised to benefit from economic reopening and recovery from the pandemic.

Quote of the week:

“Improved productivity means less human sweat, not more.”   – Henry Ford

Productivity growth + millions of available workers = less chance of a wage/price spiral

Among last week’s U.S. economic data releases, one that’s worthy of closer scrutiny is productivity (output per hour of work), a quarterly series published by the U.S. Bureau of Labor Statistics. Productivity increased at a 2.3% annualized rate in the second quarter, a somewhat slower pace than in the first but still a healthy clip, and 1.9% year over year.4 That may not sound like much, but it’s well above the 1.5% average since the 2008 financial crisis.5
Productivity growth allows wages to rise without stoking higher inflation. It’s also the product of investment in a variety of tools and resources needed to generate output, from structures to equipment to intellectual property. Historically, some investments — such as the assembly line, robotics and global e-commerce platforms — have been momentous and transformative. We don’t yet know which productivity-increasing changes from the pandemic will stick, but the massive decreases in business travel, commuting and in-store shopping precipitated by COVID-19 have certainly made the economy more productive for now.
Drilling down into second-quarter data reveals that productivity in durable goods manufacturing grew 4.6%, double the rate for the overall economy.6 But while the pace of output quickened, the amount of output fell. Increased productivity was driven by necessity because of a labor shortage. The decline in output reflected both (1) a disruption in the global supply chain for semiconductors needed to make automobiles, appliances, and other durable goods; and (2) a lack of available workers to perform the labor required to meet demand — evident in the rise in hourly compensation data for the quarter.
What conclusions might we draw from this?
  • If U.S. productivity growth remains strong, it may be key to averting a more permanent rise in inflation. That’s because when output per hour and wages increase at the same rate, producers may not feel as much pressure to raise prices.

  • Current wage pressures are not evenly dispersed, a sign that inflation drivers are still sector-specific and not broad-based. In fact, the only segment of the economy in which wages are materially above their pre-pandemic trend is leisure and hospitality. Not coincidentally, this is the sector that has been adding hundreds of thousands of workers over the past few months.

  • There’s less reason for concern about the ongoing supply and demand mismatch in the labor market. Yes, the Job Openings and Labor Turnover Survey (JOLTS) data for June, released last week, showed 10 million open positions in the U.S.,7 but that’s not overly worrisome in the context of an economy that has been generating nearly one million jobs per month over the summer. This influx of new and returning workers to the neediest parts of the labor market, along with across-the-board productivity gains, should help prevent a wage-price spiral that could lead to higher and more durable inflation.
We address the topic of inflation more fully in the next section below.

“Transitory” is true: U.S. inflation has likely peaked

July’s Consumer Price Index (CPI) report was welcomed by those who have been espousing the view that this year’s high inflation numbers were temporary. CPI readings for both headline and core (excluding food and energy) inflation slowed markedly from previous months.
One big reason: used car prices, a key component of hotter inflation in 2021, didn’t climb that much in July, and prices tied to reopening industries weren’t uniformly higher. Airfares were flat, while hotel room rates continued to surge. Restaurant menu prices increased 0.8% but are still up less than the overall inflation rate over the past 12 months.8 Interestingly, menu prices rose more at limited-service food joints than at full-service restaurants, suggesting that the bump in wages we’ve seen for these types of jobs are being passed on to customers. Gasoline remained a significant driver of headline inflation, jumping 2.4% and accounting for about 0.1% of July’s 0.5% upswing.9
The happiest development was the sharp deceleration in core prices, which exclude both menus and gas. Prices of home goods like furniture and appliances were barely changed for the second straight month, as were those for apparel after a few months of big increases. Transportation costs rose because new car prices were up 1.5%.10 Autos as a broad category (e.g., encompassing gas, insurance, used cars, rental cars) were responsible for about half the inflation experienced this past spring. But these individual aspects are no longer behaving as a monolith: used car prices edged up just 0.2% in July, and both rental car rates and car insurance premiums fell.11
Services prices, which account for over 58% of CPI, moved up 0.3%, after 0.4% increases in both May and June.12 You might see worrying headlines about an acceleration in shelter costs, but both rent and owners’ equivalent rent showed no signs of this. Rather, it was the 6.8% spike in hotel room rates that was responsible.13 In general, the services sector was relatively quiet and has been throughout this “high inflation” period.
Looking ahead, the base effects from very small CPI increases in the second half of 2020 could keep year-on-year inflation readings elevated over the balance of this year. But the key will be the monthly figures. Prices in some areas, like airfares, may have further to climb, while in others, like used cars, large price drops could start as soon as next month.
When all this comes out in the wash — by the middle of 2022, in all likelihood — we could still be in an environment of 2.5%(ish) inflation, especially if much of the current labor force slack has been used up and productivity growth trails off. Inflation at 2.5% is not an economic calamity by any means, but it would get the attention of the Federal Reserve, which is tolerant of above-target (2%) inflation, but only up to a point.
So while the days of rapidly accelerating core inflation – driven by a small number of sectors – may be over, whether the economy exits this period with inflation running hot or merely warm will determine the next steps for Fed policy, including rate hikes. We continue to expect that the Fed will use either its November or December meeting to announce plans to begin tapering its asset purchases starting in the first quarter of 2022, and that it will wait until 2023 to start raising interest rates.
  1. FactSet
  2. Treasury.gov
  3. Marketwatch
  4. Bloomberg
  5. Bloomberg
  6. U.S. Bureau of Labor Statistics
  7. U.S. Bureau of Labor Statistics
  8. U.S. Bureau of Labor Statistics
  9. U.S. Bureau of Labor Statistics
  10. U.S. Bureau of Labor Statistics
  11. U.S. Bureau of Labor Statistics
  12. U.S. Bureau of Labor Statistics
  13. U.S. Bureau of Labor Statistics
This material is prepared by and represents the views of Brian Nick, and does not necessarily represent the views of Nuveen LLC, its affiliates or other Nuveen staff.
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