Productivity Falls as Market Waits for FOMC Decision

August 10, 2010

Productivity in the U.S. fell in the second quarter as output from workers slow as the economic recovery shows signs of slowing. The U.S. Department of Labor released that Non-Farm Productivity dropped to an annualized rate of 0.9 percent. The second quarter figures surprised to the downside as consensus forecasts were calling for an increase of 0.1 percent. Partially offsetting the decline, the previous quarter was revised upward by more than a percent from an initial release to an annualized increase of 3.9 percent. The decline marks the first drop in productivity gains since the fourth quarter of 2008.

In addition, Unit Labor Costs, which is a broad based measure of inflation, came in close to flat for the second quarter and below economists’ forecasts. Unit Labor Costs increased an anemic 0.2 percent versus surveys calling for an advance of 1.5 percent. Furthermore, the previous quarter was revised downward by 2.4 percent from the initial reading to a final drop of 3.7 percent. The latest reading marks the end of the recent string in declines in Labor Costs has fallen for three straight quarters.

The drop is significant since productivity growth is crucial since it allows for higher wages and faster economic growth without inflationary consequences. Assuming stable prices, productivity growth plays a role in facilitating in increasing the overall wealth of the economy since the potential for real wages increase when workers are more productive per hour.

As the market awaits the FOMC decision on short-term rates and information on the prospects for more Quantitative Easing, the market witnessed the release of two key surveys, which revealed dimmering hopes of a sustainable economic recovery.

According to the National Federation of Independent Business, small businesses continue to be less optimistic on future business conditions. The Small Business Optimism Index fell by 1.0 percent to a reading of 88.1 in July versus 89.0 in the prior month. Analysts were expecting a higher reading for July of 88.0. While the latest release is higher from the recessionary lows set in March of 2009 of 81.0, the fact remains that it is a far from readings established after previous recessions.

After the conclusion of the 2001 recession as determined by NBER, the 12-month average of the Small Business Index was at 101.3. For the 1990-1991 downturn, the survey averaged 98.5 in the following year.

The numbers behind the headlines reveal a less encouraging outlook. Of the small companies reporting, a net 2 percent of responding small businesses plan to add workers in the next three months indicating lackluster job growth (net number equals the number of small businesses offering a positive response less the number of companies providing a negative one). The net number of companies planning to increase inventory declined to -4 percent from -3 percent in June.

Interestingly, the net number of companies that expect a better economy fell off a cliff. The net number expecting better prospects dropped from -6 percent in June to -15 percent in July. For comparison purposes, this particular component dropped from a net number reading of -10 to -22 from December 2007 to January 2008, which is the period that marks the official beginning of the recession.

In addition, the net number of companies who think that access to loans is getting easier continues to deteriorate from -13 percent to -14 percent in July. As Ben Bernanke stated early last month in a conference held in Washington DC addressing the needs of small businesses, extending credit for companies with limited workforce are the key to a U.S. economic recovery. Conditions have not changed for small businesses and as a result, this should not bode well for the recovery going forward.

Finally, Investors Business Daily released numbers suggesting that optimism for the U.S economy continues to decline. The IBD Economic Optimism Index dropped from 44.7 set in July to an August reading of 43.6. The decline disappointed as economists were expecting an increase to 45.0 based off Bloomberg surveys.

The markets are in stand-by mode as rates are generally flat to slightly higher. The 2-Year Treasury is trading at 0.55 percent, up 2 basis points from yesterday but continues to hover near recent lows. The 10-Year is flat at 2.83 percent. Stocks are finally showing some doubt of the recovery it seems and is down by close to a percent to 1116.96, which is kissing support levels in the 200-day moving average. Check back later for an update on the markets after today’s key FOMC rate decision.