Friday, May 6, 2022

Labor Costs Soar, Productivity Turns Negative, Fed In A Bind

 Data for labor costs and productivity were released yesterday.  Predictably, costs rose at the fastest rate in 40 years and productivity turned negative.

Unit Labor Costs (blue line) and Labor Productivity (red line)

As we know, inflation becomes "baked in" to the system as labor costs rise, with workers expecting larger pay increases to combat inflation. Essentially, it creates a self-reinforcing inflationary loop feeding on itself; it is the Fed's greatest fear - and rightly so.

To make matters worse - or better, depending on which side of the fence you are sitting - unemployment is just about the lowest in history: continued claims for unemployment insurance at 1.38 million are the lowest since 1970. 

Continued Claims Lowest Since 1970

Massive government handouts and two years of pandemic restrictions resulted in a vertical rise in bank deposits, creating the fuel for very strong consumer spending - thus, even more inflation.

Demand Deposits In Banks Soared

Conclusion: The Fed has no choice but to step hard on the brakes to combat inflation.  In my opinion, whoever believes in a "soft landing" may as well believe in the Tooth Fairy.


  1. The "no 75 bp hike" comment was transitory, lol.

  2. You know, I was thinking about it (without models for once)...

    If Fed raises rates, many factories / enterprises in Asia will go bankrupt... This should reduce supply, which should raise prices... which means more inflation...

    Thus, in the short term, we reach the weird conclusion that raising interest rates will increase inflation...

    I am not saying this is what I believe... more of a random thought that I am throwing out there

  3. I know about the idea of raising interest rates reduces demand... but that seems to work primarily when the demand is based on credit... if the money is already in the accounts, maybe raising interest rates does not change demand.

    1. In order for higher interest rates to reduce demand they must be higher than inflation, so that consumers will choose to save rather than buy things before prices rise.

    2. yes, that is a much better way to put things.

      so in summary:

      case 1: if U.S. raises rates and Asia follows suit, demand should stay constant and supply should reduce, thus inflation should rise.

      case 2: if U.S. raises rates and Asia does not follow, the asian currencies should devalue. In which case, demand should stay constant but goods will be cheaper, thus inflation should go down.

      Personally, I think case 2 will occur...

    3. We (the West) have a services economy: everything from movie and a dinner, to retirement home services. Upward wage pressures there - already very evident - have a much more permanent impact on Western inflation than prices for goods imported from Asia.

      This is what is happening right now and the ONLY way to stop it is to create a recession, deep and long enough to raise unemployment high enough so that wage pressure disappears. Not nice…