| BUSINESSWEEK ONLINE : AUGUST 30, 1999 ISSUE | ||||||||
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| BUSINESS OUTLOOK
U.S.: More Fuel for Another Fed Hike News from the labor front supports further tightening Once again, the Federal Reserve is casting its long shadow across Wall Street. Ever since Fed Chairman Alan Greenspan in several speeches this summer clearly linked future policy decisions to the behavior of the labor markets, the data on everything from job growth to labor costs to productivity have moved in the wrong direction for anyone hoping that the Fed's June 30 rate hike was a one-shot deal. After that move, few analysts expected another rate increase as early as the Fed's upcoming Aug. 24 meeting. Now, investors are starting to build that possibility into the prices of stocks and bonds (chart). The surprisingly strong employment report for July galvanized Wall Street's worries about the third quarter and beyond. Nonfarm payrolls ballooned by 310,000 workers, providing further evidence that the U.S. spending boom continues to drain the pool of potential workers. A more concrete sign of that was July's 0.5% jump in hourly pay, suggesting that tight labor markets are pushing up wage growth. Also, manufacturing payrolls posted their first material increase in 1 1/2 years, implying that the industrial sector is kicking into a higher gear after last year's sluggishness. A manufacturing upturn will place added pressure on the economy's already-thin labor resources. The numbers play squarely into Greenspan's July 22 vow to act ''promptly and forcefully'' if new data suggest that cost and price increases will be picking up. KEEP IN MIND that the June 30 rate increase was not so much a tightening move as it was an attempt to take back part of last fall's ''emergency injection of liquidity,'' as the Fed has called those three quarter-point rate cuts in the face of global financial market turmoil. The July employment report provides further evidence that those cuts ended up giving the economy too much stimulus and that a further policy adjustment may be needed quickly. First, the July job gain was far larger than the 200,000 or so that the markets had expected. Second, the gains were the broadest of the year. Some 59% of the 356 industries that the Labor Dept. surveys added workers to their payrolls. Service industries posted a big 260,000 gain, led by retail trade, up 91,000, and by personnel-supply companies, up 41,000. Construction added 22,000 new employees. But the biggest news on the job front came from manufacturers, which added 31,000 workers, after shedding 490,000 jobs during the previous 15 months. Also, the factory workweek increased by 12 minutes, to 41.9 hours, the longest in 1 1/2 years. Taken together, those indicators imply that factory production in July posted a strong gain, continuing the acceleration in output growth that began earlier this year. The two factors that were a drag on manufacturing output are now turning around: Foreign demand is picking up after a two-year slump, and inventories need to be rebuilt after last year's slower rate of stockpiling. Indeed, factory shipments are growing faster than inventories, and in June, the ratio of factory inventories to sales was the smallest on record. Meanwhile, domestic demand shows no sign of flagging. Perhaps the most worrisome news from the July job data--at least from the markets' perspective--was the jump in pay for production workers. The rise suggested that the sharp increase in labor costs in the second quarter did not abate at the start of the third quarter. Also, the increase was not just a one-month wonder. Pay in the past three months has risen at an annual rate of 4.6%, the fastest three-month pace in more than a year (chart). In addition, pay growth from a year ago appears to be picking up again, led by pay in manufacturing, after slowing during the past year. TO BE SURE, some of the recent top-line data suggest less urgency for Fed action. For instance, the unemployment rate in July held at 4.3%, about where it has been for the past nine months. And annual trends show that unit labor costs remain tame and that productivity is still growing strongly, even though the latest quarterly data show that costs soared in the second quarter, while output per hour worked sagged. In fact, prior to last quarter, the trends in wages and productivity could not have been more soothing to inflation worrywarts. Not only was wage growth slowing, but at the same time, productivity growth was picking up. That's why the second-quarter slowdown in productivity, to an annual rate of 1.3%, after very strong gains averaging nearly 4% in the two previous quarters, raised a red flag. It brought to mind Greenspan's recent warning: ''Should productivity fail to continue to accelerate and demand growth persist or strengthen, the economy could overheat.'' THE DISAPPOINTING REPORT on productivity, though, raises the question: How could profit growth in the second quarter have been so robust if labor costs were out of control? The explanation lies in the yearly trend in the data. When smoothed out over time, productivity is growing quite powerfully. It advanced 2.9% in the past year, the highest clip in 6 1/2 years (chart), holding the growth in unit labor costs to only 1.4%. However, productivity will have to stay that strong in order to prevent any pickup in wage growth from compelling companies to raise prices. That's because the measure of compensation in the Labor Dept.'s productivity-and-costs report, which covers a broad range of wages, salaries, and benefits, including stock options, soared at a 5% annual rate, the largest increase in 1 1/2 years, and growth from a year ago was 4.3%. If productivity slows, unit abor costs will shoot up rapidly, placing pressure on companies at a time when demand is strong, when labor markets are tight, and when prices in the early stages of processing are already starting to strengthen. In fact, third-quarter productivity may not look any better than it did in the second. That's because hours worked rose sizably in both June and July, suggesting a large increase in work time in the third quarter. For example, if hours rise 3.5%, which is not unreasonable based on their July increase, then output would have to surge more than 6% for productivity to maintain its 2.9% annual growth trend. That's not impossible, but it is unlikely. Of course, Wall Street doesn't always get it right. After the June 30 rate hike, the financial markets' collective wisdom concluded that the Fed was on hold, perhaps for the rest of the year. This time, however, the markets may be on to something. They are worried that the conditions for future rate hikes--as laid out by Greenspan himself--are falling into place. And whatever probability you had assigned to the likelihood of an Aug. 24 rate hike prior to the July job data, you must raise those odds now. BY JAMES C. COOPER & KATHLEEN MADIGAN _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ BACK TO TOP |
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RELATED ITEMS U.S.: More Fuel for Another Fed Hike CHART: Bond Yields Hit a 21-Month High CHART: Is Wage Growth Speeding Up Again? CHART: The Productivity Trend Remains Strong INTERACT E-Mail to Business Week Online | |||
