Inflation Is Coming From Inside The House!

In Q1, US labor productivity plunged by the most in almost 80 years.

Data for Q2, out Tuesday, was expected to show another outsized decline. And it did.

Nonfarm productivity fell 4.6% in the second quarter, the BLS said (figure below). That was in line with consensus. The range of estimates, from nearly four-dozen economists, was -6% to -1.5%.

For those unfamiliar, this is just output per hour — output divided by hours worked. It’s usually volatile, and drawing conclusions about the impact of the pandemic on trends in labor productivity will be a fool’s errand for the foreseeable future.

Nevertheless, you’d be remiss not to take note of Q2’s plunge which, albeit smaller than Q1’s drop, counted among the biggest in modern US history.

Note that nonfarm business output shrank a second quarter in Q2 (figure below).

Slower (or negative) growth alongside robust hiring puts downward pressure on productivity. Hours worked rose 2.6% in Q2, Tuesday’s data showed.

When you juxtapose plunging productivity with surging wages and comp, you end up with soaring unit labor costs. Sure enough, they (unit labor costs) jumped nearly 11% in Q2, an “impressive” (although I’m not sure that’s the best word choice) encore from an upwardly revised 12.7% in Q1.

Outside of the pandemic distortions during the fist half of 2020, the last time unit labor costs rose double-digits (SAAR) during two straight quarters was 1982. Speaking of 1982, the four-quarter increase, 9.5%, was the largest since Q1 of that year and among the largest on record (figure below).

Again, that’s the result of rising hourly labor costs alongside falling productivity, and it reinforces sundry wage-price spiral narratives.

I’ll recycle some language from last quarter. Inflation isn’t solely due to exogenous phenomena and bad luck. To channel an old horror movie cliché, “The call is coming from inside the house!”

That’s one read-through for the Fed. Or at least they’ll perceive it as such.

Hourly compensation rose 5.7% in Q2. Real hourly compensation — so, inflation-adjusted comp — fell 4.4% for the second quarter in a row.