Morning Report: Productivity Collapses

Vital Statistics:

  Last Change
S&P futures 4,656 6.2
Oil (WTI) 82.53 1.63
10 year government bond yield   1.56%
30 year fixed rate mortgage   3.25%

Stocks are higher this morning after the Fed announced its tapering policy yesterday. Bonds and MBS are flat.


As expected, the Fed announced that it will start reducing its MBS and Treasury purchases as it unwinds its COVID support. It will reduce its Treasury purchases by $10 billion per month and MBS purchases by $5 billion per month and should complete this process by summer next year.

The reaction in the bond market was muted. Rates ticked up 3 or 4 basis points and we are back to pre-meeting levels this morning.

The Fed Funds futures became slightly more dovish, with investors trimming their bets on the extreme rate hike scenarios. The consensus seems to be that we will see two rate hikes next year.


Initial Jobless Claims feel to 269,000 last week. It appears that we are getting closer to pre-COVID numbers, but we still need about a 22% reduction to get back to pre-COVID normalcy. Separately, companies announced 22k job cuts last month, according to Challenger, Gray and Christmas.


Productivity fell by 5% in the third quarter, as output increased 1.7% and unit labor costs rose 8.3%. This is an awful report. There is no way to sugar-coat it. Output (i.e. GDP growth) is tepid, while costs are rising. This translates into inflationary non-growth, aka stagflation. The Fed has a tough line to walk here.

The Fed is betting that the supply chain issues are in fact temporary, and it needs that to be the case in order to stick the landing. If the supply chain issues translate into persistent inflation, then we are pretty much in a replay of the late 1970s. Inflation picks up -> Fed tightens -> Economy goes into recession -> Fed eases to boost economy -> Inflation rises faster. Inflation spirals higher while the economy vacillates between mild recessions and mild recoveries.

This set of affairs ended up causing what was then known as the “misery index” which was the sum of inflation, unemployment and interest rates. They only thing that will break that cycle is that the supply chain issues work themselves out and inflation returns to its normal 2% level. If so, then the Fed can take its time raising rates. Otherwise we could be in for a bumpy ride over the next year.

In the 1960s, it was hip amongst macro-economists to try and “fine tune” the economy. The hope was that fiscal and monetary policy could engineer out the business cycle and create a permanent prosperity. Guys like Paul Krugman were raised on that mindset. From the mid 1960s through the late 1970s, left-Econ ran the show. Fiscal policy through “guns and butter” and new entitlements was exceptionally loose. The government closed the gold window, which ended any discipline with interest rates. Rates rose and nearly killed the banking system as depositors fled the banks, which were limited by law to cap deposit rates at 5%. Eventually the whole thing devolved into stagflation, and Econ in general began to realize there are limits to economic engineering.

Fast forward to today: we are in a very similar position. Left Econ has run the show since 2008. Government spending has soared, and the Fed has been running an unprecedented experiment in the financial markets, trying to manage the economy by purchasing trillions of Treasuries and mortgage backed securities. While it is possible that government (fiscal and monetary) policy can extricate itself from the economy, it looks like the powers-that-be might have engineered the same result as the 1970s.

The parallels are there.

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