Weekly Market Update – U.S. Worker Productivity Surges: Implications for Economic Policy and Inflation            

What We’re Watching this Week:

  • Consumer credit indicates consumer strength
  • Wholesale inventories
  • Jobless claims

Highlights from Last Week:

  • ADP Payroll Employment Report
  • Job Openings Report reflecting labor market strength
  • U.S. Federal Reserve rate announcement
  • U.S. Non-farm payrolls

The North American equity markets recorded solid weekly gains, with decreased long-term bond yields and the Federal Reserve’s perceived dovish policy statement contributing to the positive sentiment. While growth stocks and the tech-heavy Nasdaq Composite Index outperformed, the gains were broad-based, led by the small-cap Russell 2000 Index, which saw its best weekly performance since October 2022. The TSX also participated with substantial gains despite oil losing over 5% in the week. The week featured various factors for investors, including earnings, policy statements, economic reports and geopolitical developments. The Fed policy meeting, in particular, influenced market sentiment. Although the Fed maintained interest rates, the post-meeting statement indicated that the recent rise in long-term Treasury yields had achieved some of the intended financial tightening. Fed officials also appeared comfortable with the robust economic growth, describing it as “strong” instead of “solid.” In Europe, the STOXX Europe 600 Index rebounded, with major stock indexes in Italy, France, Germany and the U.K. posting gains as expectations of stabilized interest rates contributed to the positive market sentiment.

On Tuesday, the S&P CoreLogic Case-Shiller Home Prices Indices in the 20 largest U.S. metropolitan areas increased for the sixth consecutive month due to a shortage of homes for sale. The 20-city house price index saw a 1% rise in August compared to the previous month, with a 2.2% national year-over-year increase. Chicago led with a 5% year-over-year gain, followed by New York and Detroit at 4.98% and 4.8%, respectively. The western housing market lagged, with price declines in Las Vegas and Phoenix. The Federal Housing Finance Agency reported a 0.6% monthly increase and a 5.6% yearly rise in home prices. A strong seller’s market is expected to persist due to limited inventory. 1

In October, U.S. businesses added 113,000 new jobs, falling short of economists’ expectations of 130,000, as reported by ADP on Wednesday. While this figure provides insights into the labor market’s strength, it is not a precise predictor of the government’s official employment report, which will be released later in the week. The government’s report was anticipated to show 170,000 new jobs, including government hires, though ADP’s report does not consider government employment. The strongest job growth occurred in education, healthcare, transportation, leisure, hospitality, and financial services, with 45,000 jobs created in these sectors. Most of the job gains came from midsized businesses in the South and the West, while employment in the Midwest decreased. Wage growth slowed, with a 5.7% increase in pay for those remaining in the same job, down from the previous month’s 5.9%. Job changers experienced an 8.4% pay increase over the past year, down from 9%. ADP’s September employment estimate remained at 89,000, significantly lower than the government’s official report, which indicated a gain of 336,000 jobs in September. The labor market has slightly softened but remains robust, with record-low layoffs and a 3.8% unemployment rate. However, the Fed aims for slower hiring and wage growth to aid its efforts in tackling inflation. The labor market’s performance is scrutinized, as it plays a crucial role in economic policy decisions.2

Later on Wednesday, the Bureau of Labor Statistics reported in September, job openings in the U.S. increased slightly to 9.6 million, reflecting strong labor demand in the growing economy. This figure increased from a revised 9.5 million job openings in August, exceeding economists’ expectations of 9.4 million. While job listings remain high, they have decreased from a record 12 million in 2022. Senior Fed officials are keen to see job openings decline further to relieve wage pressure and control inflation. The number of people quitting jobs held steady at 3.6 million, as it did not change from the previous month. Last year, the number of job quitters reached as high as 4.5 million, but it has since stabilized. When the economy softens and jobs become scarcer, people tend to quit less frequently and stay in their current positions. Job openings increased in hotels, restaurants, arts, entertainment, and recreation sectors, which typically thrive when the economy is strong. Employment declined in the federal government and information-related services like media. The ratio of job openings to unemployed workers remained at 1.5 in September, down from its peak of 2% in 2022. The Fed aims to see it return to pre-pandemic norms of around 1.2. The quits rate among private-sector workers was unchanged at 2.6%, back to pre-pandemic levels. Overall, the labor market remains robust, but if labor shortages persist and wages rise rapidly, a wage-price spiral could lead to persistently high inflation, posing a threat to the ongoing economic expansion if the Fed is forced to raise interest rates further.3

In October, the Institute for Supply Management (ISM) reported that the closely watched index measuring U.S. manufacturing activity dropped by 2.3 points to 46.7, marking the lowest level since July. This decline was a surprise, as economists expected the index to increase to 49.2%. A reading below 50% indicates a contraction in manufacturing activity, and this sector has been contracting for the past year. The report revealed that new orders, production, and employment weakened in October, with only two manufacturing industries reporting growth, while 13 reported contractions. However, a separate report, the S&P Global Markit PMI, showed a slight increase from 49.8 in September to 50 in October. The decline in the ISM index was attributed to various factors, including higher interest rates leading firms to scale back capital spending plans and potential impacts from the United Auto Workers strike. Timothy Fiore, chair of the ISM’s factory survey committee, expressed concern about the lack of new orders and a weak backlog of orders, suggesting that tight Federal Reserve monetary policy may be influencing reduced investment spending. Overall, the manufacturing sector is facing challenges and uncertainties.4

The Fed has chosen to maintain a key interest rate at a 22-year high, holding it within a range of 5.25% to 5.5%. This decision was unanimous, reflecting the Fed’s deliberation over how to raise interest rates further to counter inflation and economic growth without triggering a recession. Despite robust economic expansion in the third quarter, Fed Chairman Jerome Powell asserted that a series of interest rate hikes implemented since 2022 is already curbing inflation and economic growth. Powell expects the economy to gradually soften in the coming months but clarified that a recession is not in the forecast. The Fed’s statement mentioned the need to assess a broad range of data to determine whether additional rate hikes are necessary to return inflation to 2% over time, given the current inflation rate of 3.4% to 3.7%. Another factor affecting the decision is the surge in interest rates on longer-term bonds, which has increased the costs of home purchases and business borrowing. The Fed acknowledged the impact of this tightening of “financial conditions” and noted that further rate hikes may be limited if long-term rates remain persistently high. Despite raising interest rates steadily since March 2022, the Fed has only implemented a 25-basis-point rate hike since June, demonstrating caution about overtightening and the risk of causing a recession. Fed officials have increasingly emphasized the need to maintain peak rates for longer to keep downward pressure on inflation. Economists are divided on the economic outlook and interest rate policy, with high uncertainty prevailing. While some believe the Fed may not raise rates again in the current business cycle, others argue for further hikes as a precaution against potential inflation resurgence. The Fed has anticipated one more rate hike, but the timing remains uncertain. The Biden White House will closely monitor these developments in anticipation of the upcoming presidential election, with the economic outlook playing a pivotal role.5

On Thursday, the Labor Department reported that the number of Americans filing for unemployment benefits increased by 5,000 to 217,000, marking a seven-week high, indicating a slight softening in the robust U.S. labor market. This figure rose from a revised 212,000 in the previous week. While it suggests some weakening, it’s important to note that the number of job losses remains very low, indicating a stable economy. Economists had expected new claims for the week ending October 28 to be around 210,000. Additionally, the number of individuals receiving unemployment benefits from all programs in the U.S. rose to a seven-month high of 1.82 million, indicating a potential delay in job finding, which suggests a slowdown in hiring. Overall, the labor market remains relatively strong, with businesses holding onto employees amid a severe labor shortage.6

In the third quarter, U.S. worker productivity surged at a 4.7% annual rate, exceeding economists’ expectations for a 4.3% decline. This is the fastest productivity growth since the third quarter of 2020. Output in Q3 increased by 5.9%, while hours worked rose by 1.1%. Unit labor costs, a measure of wages, fell by 0.8% in the third quarter, the first decline since the previous year’s fourth quarter. Unit labor costs rose by 1.9% in Q3, down from the prior quarter’s 3.7% increase on a year-over-year basis. Rebounding productivity is beneficial for raising living standards and mitigating wage-driven inflation, possibly impacting the Federal Reserve’s approach to economic policy. Some economists believe a higher productivity trend is emerging, while others are more cautious about making definitive conclusions.7

On Friday, the Bureau of Labor Statistics reported that the U.S. added a modest 150,000 new jobs in October, indicating a cooling labor demand exacerbated by higher interest rates. Economists had anticipated 170,000 jobs but might have reached 180,000 without an auto workers’ strike. This figure represents a significant slowdown from the downwardly revised 297,000 increases in September, which had initially appeared as an outlier. The unemployment rate increased to 3.9%, the highest level since early 2022. The Federal Reserve anticipates a further softening of the labor market, which could alleviate upward pressure on labor costs and potentially allow them to conclude their current interest-rate increase cycle. Despite a slight rise in labor costs in October, average hourly wages increased by 0.2%, while the year-over-year wage growth slowed to a 2.5-year low of 4.1%. While the labor market remains relatively strong, businesses are hiring fewer people due to labor shortages and slow sales, particularly in interest-rate-sensitive industries. As long as most people stay employed and spend money, the U.S. is expected to avoid a recession. However, a substantial drop in business sales and profits could lead to layoffs, posing a risk to the ongoing economic expansion.8

In October, the ISM (Institute for Supply Management) index for U.S. service-oriented businesses, including retailers and restaurants, dropped to a five-month low of 51.8%, signaling a slowdown in the economy. This reading was below the economist-forecasted 53.0% and down from September’s 53.6%. Numbers above 50% are considered positive for the economy, and the index has fluctuated between 50% and 55% this year. Key details from the report include a decline of 4.7 points in the production gauge to 54.1%, an increase of 3.7 points in the new-orders index to 55.5%, a 3.2-point drop in the employment barometer to 50.2%, and a nearly unchanged prices-paid index at 58.6%, reflecting ongoing concerns about inflation. While the economy expanded rapidly in the third quarter, higher interest rates and persistent inflation are expected to slow down the economy in the latter part of the year. The October ISM report suggests this softening trend.9


1 https://www.spglobal.com/spdji/en/documents/indexnews/announcements/20230926-1466568/1466568_cshomeprice-release-0926.pdf

2 https://adp-ri-nrip-static.adp.com/artifacts/us_ner/20231101/ADP_NATIONAL_EMPLOYMENT_REPORT_Press_Release_2023_10%20FINAL.pdf

3 https://www.bls.gov/news.release/pdf/jolts.pdf

4 https://www.ismworld.org/supply-management-news-and-reports/reports/ism-report-on-business/pmi/september/

5 https://www.federalreserve.gov/newsevents/pressreleases/monetary20231101a1.htm

6 https://www.dol.gov/ui/data.pdf

7 https://www.bls.gov/news.release/archives/prod2_11022023.htm

8 https://www.bls.gov/news.release/empsit.nr0.htm

9 https://www.prnewswire.com/news-releases/services-pmi-at-51-8-october-2023-services-ism-report-on-business-301976221.html

Important Information:

Warren Gerow is an independent investment wealth consultant to Sightline Wealth Management.

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