USD: Question mark over the productivity - Rabobank

Discussion in 'Fundamental Analysis' started by FXStreet_Team, Mar 4, 2016.

  1. FXStreet_Team

    FXStreet_Team Well-Known Member Trader

    Oct 7, 2015
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    Jane Foley, Research Analyst at Rabobank, notes that since the middle of February measures of US breakeven inflation rates have been ticking higher and this corresponds with slightly firmer than expected readings for US January CPI and PCE inflation.

    Key Quotes

    “These data releases have forced investors to consider whether the market was too hasty earlier this year in pricing out the possibility of a Fed rate hike later in 2016. If today’s US February labour data release brings another solid rise in employment and an uptick in wage inflation, break-even inflation rates are likely to tick higher still and the USD is likely to find support.

    US average hourly earnings rose at a rate of 2.5% y/y in January and is expected to have held steady at this level in February. Although there has been an upward bias in this series since the start of last year, US wage inflation is holding well below the average rate of 3.2% y/y that held between early 2007 and early 2009.

    One of the explanations for this is that productivity growth has also been stalling in this period. Low productivity growth tends to put a cap on wage inflation because if wage rises are higher than productivity growth the obvious implication is that unit wage costs increase. In this scenario firms may then try to cut costs (possibly by shrinking the workforce) or may attempt to pass on these costs through higher prices. The resultant cost led inflation is far less desirable than the demand pull alternative.

    Yesterday’s publication of final US Q4 productivity data at -2.2% saar was a little better than the -3% saar initial projection. That said, since the end of 1994 only 4 quarters have seen a bigger decline. According to the US Bureau of Labour Statistics the average annual percentage change in US productivity in the non-farm business sector between 2007 and 2015 was 1.2%. This matches the reading for 1973-1979 but is otherwise far lower than in any other period since 1947. In the period 2000 to 2009 productivity grew at an average annual rate of 2.6%.

    Low productivity growth in addition to excessively high debt levels and are commonly cited as restraints to growth in some of the world’s largest economies. There is no clear consensus on why productivity growth is failing to pick up but the obvious conclusion is that there has been systematic under investment in education and resources needed to boost skills. While lower levels of productivity imply slower wage growth, consumers in many economies have in recent years been able to turn to cheap credit to fulfil lifestyle expectations. That said, once demand for credit becomes saturated, the economy is left facing weak demand and slow growth.

    The implication of the reasoning above is that high debt levels and low productivity are part of the same problem. Structural reform and an increase in productivity boosting investment may be a solution but clearly this takes times. Until more positive signs of productivity growth emerge there is a strong likelihood that wage growth will remain constrained.

    The issue of weak wage inflation is not confined to the US. The issue is arguably a greater problem for countries such as the Australia and the UK. In the US we see sufficient improvement in many of the dynamics of the economy to justify up to two rate hike from the Fed later this year. This outlook suggests that the USD should be able to claw back some lost ground vs. a number of major currencies albeit at a moderate pace.

    A decent set of US data this afternoon would play into the hands of ECB President Draghi insofar as it would increase the likelihood that a step up in easing measures from the Governing Committee next week could create a downdraught in EUR/USD. Assuming a gradual improvement in US data, we expect EUR/USD to edge towards 1.07 in H2.”
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