KEY DATA:  Productivity: +2.3%; Unit Labor Costs: +1%; Real Compensation: -4.8%/ NFIB: -2.8 points; Future Conditions: -8 points

IN A NUTSHELL: “Businesses continue to operate very efficiently, which should help keep earnings solid.”

WHAT IT MEANS: The economy soared in the second quarter and that was good news for nonfarm businesses.  The sharp 7.9% rise in output more than offset the 5.5% robust gain in hours worked and as a result, productivity increased at a solid pace.  The increase in efficiency also largely offset the surge in hourly compensation, so labor costs rose at a modest pace.  While businesses did well in the spring, things were quite as good for workers.  Yes, it was nice to see that hourly wages rose strong pace, but inflation soared even faster.  That led to a sharp decline in real, or inflation-adjusted compensation. 

Small businesses should be happy about the reopening of the economy, and they were for a while.  But conditions could be changing, at least a little.  The National Federation of Small Businesses’ optimism index decline in July.  There had been a nice bump up in June, but that disappeared and the level is similar to what we have seen for four of the last five months.  For the eight consecutive month, the outlook for business conditions was negative and it dropped sharply in July.  Earnings expectations are also negative, not a good sign for hiring or expansion.  The big problem remains costs, both labor and nonlabor.  Input expenses are rising sharply and actual compensation increases are exceeding expected ones.  The lack of qualified workers is also a major issue, with a record 49% of the respondents saying they could not fill positions.       

IMPLICATIONS: There is good news and bad news in today’s reports.  The sudden reopening of the economy has not caused business labor costs to rise significantly, as production gains outstripped rising labor costs.  When you add in inflation, compensation expenses are dropping at a rapid pace.  Thus, corporate earnings should be holding up.  But that also means workers’ spending power is beginning to falter.  That is not good news, especially for small businesses who are already concerned about the future.  Still, there are no signs that the economy is downshifting.  July’s job gains were massive and with so many more people working, it can only mean that total income is rising solidly.  The conundrum the Fed faces is that the current data do not support its massive liquidity program.  But uncertainties about the future argue for it to stay the course, at least for a while.  Once again, when facing a “do too much” vs. “do too little” choice, the Fed is likely to do too much.  It is easier to slow growth than accelerate it and with rates so low, it has a lot of arrows to fire at any inflation threat.