Are Rising Productivity and Unit Labor Costs Helping the Rate Hike Case?

It is no secret that the Federal Reserve wants to begin hiking interest rates. Fed funds have been kept at near-zero, in a range of 0.00% to 0.25%, for almost two presidential terms. The Fed has a dual mandate for full employment and to keep inflation in check. So what happens when the Fed has to digest a period of no significant inflation at all with rising productivity and rising labor costs?

A report on Wednesday from the U.S. Bureau of Labor Statistics (BLS) showed both productivity and unit labor costs were higher in the third quarter. While these are revisions, they are key issues for determining what is happening inside the business community on output and wage pressure. They are of course backward-looking due to being a third-quarter report, but they also give the Fed some hopes to hang on for the “inflation case” in the decision to finally raise fed funds in December.

Again, the Fed needs full employment (or close to it) and needs signs that inflation is at (or could soon be nearing) 2.0% to 2.5% for its current trigger mechanism of a rate hike. It turns out that these are not set in stone, but Fed Chair Janet Yellen and fellow Fed presidents do not want to be judged by the history books as having done the exact wrong thing by raising interest rates when the domestic economic picture is mixed to negative and when international economic opportunities are becoming fewer and fewer.

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Nonfarm business sector labor productivity increased at a 2.2% rate (annualized) during the third quarter of 2015. Output increased by 1.8%, and the hours worked decreased by 0.3%. The decline in hours worked was the first decline in this series since the third quarter of 2009. Where the less-good image sits is that productivity increased 0.6% from the third quarter of 2014 to the third quarter of 2015, reflecting increases in output and hours worked of 2.5% and 1.9%.

Unit labor costs in the nonfarm sector rose by 1.8% in the third quarter of 2015. What stands out here is that there was a 4.0% rise in hourly compensation and a 2.2% gain in productivity. Unit labor costs have risen by 3.0% over the past four quarters.

Wednesday’s BLS report said:

Manufacturing sector labor productivity increased 5.1 percent in the third quarter of 2015—the largest gain since a 6.1-percent increase in the third quarter of 2011—as output increased 3.2 percent and hours worked decreased 1.8 percent. Productivity increased 6.9 percent in the durable goods manufacturing sector and increased 2.3 percent in the nondurable goods sector.

The 2.2% gain in nonfarm productivity met the Bloomberg consensus estimate but was higher than the 1.6% prior gain. The 1.8% rise in unit labor costs is twice the gain that Bloomberg was calling for and was four-tenths of a percent higher than the prior report.

The BLS gave explanations for the higher revisions. The new figure reflects an upward revision to output that was larger than a small upward revision to hours. Unit labor costs were revised up due to hourly compensation growth. In the manufacturing sector, productivity’s upward revision to output was larger than the upward revision to hours.

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