KEY DATA: Productivity: +2.5%; Output: +5.2%; Real Hourly Compensation: +0.1%; Unit Labor Costs: 0.6%
IN A NUTSHELL: “Productivity rebounded, keeping business costs low as wage gains remain largely under control.”
WHAT IT MEANS: Rising wages don’t have to be a major problem for firms as long as workers offset those increases with improved output. Unit labor costs, which reflect the balance between wages and production, edged upward in the spring. Strong spring economic growth, a reflection of the rebound from the winter weather-restrained production in the first quarter, offset an increase in wages. Indeed, there was a huge rise in labor costs in the first quarter, which points out that the quarter-to-quarter numbers really don’t mean a whole lot. Smoothing out the data by looking at the year-over-year numbers gives a better indication of what is happening with productivity and costs. If you want to know about the potential for consumer spending to rise faster, just look at compensation adjusted for inflation. Real hourly compensation was at the same level in 2013 as it was in 2007. But that may finally be changing, at least a little. While workers inflation-adjusted income fell by 0.3% in 2013, it is rising at about a 1.5% during the first half of the year. If wage gains accelerate, as I expect, we might actually hit 2%. Will that cause business labor costs to rise? Probably, but not necessarily a whole lot. Productivity will likely rise about 1.5% to 2% this year so labor costs should be mostly offset by additional worker output. But we may see unit labor costs look a lot less positive for businesses than they have been the case for a decade.
MARKETS AND FED POLICY IMPLICATIONS: Labor costs are and will be the focus of attention for a very long time. Yesterday’s unemployment claims report points to strong job gains and a decline in the unemployment rate. Full employment is on the horizon, whether the business community wants to accept that or not. Today’s report doesn’t say that labor costs are a problem yet, but it hints at some improvement in pay. That is good. Real worker compensation has essentially gone nowhere for six years, so how can anyone think that people will be able to shop ‘till they’re tired let alone ‘till they drop unless wages rise solidly? The Fed members, at least the inflation hawks, will likely look at the report as supporting their view that it is time to change direction. But investors will probably take solace from the headline number, which implies that labor costs are again well contained. These numbers are hugely volatile and believing the quarterly numbers mean anything is a short-cut to muddled thinking. Regardless, with geopolitical issues heating up, who knows what will drive the markets these days.