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Is Inflation Lurking Despite High Unemployment?

By Rom Badilla, CFA, Bondsquawk

After a dearth of major macro releases the last couple of days, yesterday’s economic data releases show that productivity and wages for U.S. workers increased which may bode well for future consumer spending and economic growth.

The U.S. Department of Labor reported that Productivity which measures the growth of labor efficiency, in the second quarter improved by 1.6%. The increase surprised to the upside as consensus surveys were expecting 1.4%. In addition, this uptick follows an upward revision to the previous quarter of -0.5% from an initial report of -0.9%.

Furthermore, Unit Labor Costs (ULCs) which reflect worker compensation in producing each unit of output increased more which may indicate inflation in the pipeline. Unit Labor Costs increased by 1.7% in the second quarter versus expectations by market forecasters of just 0.5%. Also, the previous quarter’s advance which was initially reported at 1.3%, was revised even higher to 5.6%.

While generally positive from the standpoint of consumer spending, the two indicators may signal inflationary trends. Deutsche Bank economist, Joseph LaVorgna provided the following color on yesterday’s data releases:

“Faster compensation, largely the result of expanding wage and salary income, is a net positive for stronger second half consumer spending. And given the recent trends in productivity and compensation growth, the growth rate in ULCs is bound to accelerate from its current +0.8% year-over-year rate. This is central to the longer term outlook for monetary policy because the economy is generating more ULC growth then standard output gap models would imply. In other words, inflation pressures are lurking below the surface of the labor market despite the fact that unemployment is high.”

Given yesterday’s data coupled with the uptick in Friday’s Unemployment Rate, the Federal Reserve might be stuck between a rock and a hard place as they fight the war on two fronts, both high unemployment and potential price pressures building in the pipeline. While yesterday’s data isn’t enough to warrant the Federal Reserve to tighten policy, it may be another piece of evidence to keep them from easing further via QE and expanding their balance sheet at their next FOMC meeting.