Bridgewater Associates: Labour Dynamics and Fed Policy - February 2006
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Bridgewater Associates: Labour Dynamics and Fed Policy - February 2006

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Bridgewater Associates: Collection of Writings (1999-2012)

Bridgewater Associates: Collection of Writings (1999-2012)

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Bridgewater Associates: Labour Dynamics and Fed Policy - February 2006 Bridgewater Associates: Labour Dynamics and Fed Policy - February 2006 Document Transcript

  • Bridgewater ® Daily Observations is protected by copyright. No part of the Bridgewater ® Daily Observations can be duplicated or redistributed without prior consent from Bridgewater Associates. Copying or redistribution of The Bridgewater ® Daily Observations is in violation of the U.S. Federal copyright law (T 17,U.S. code). 1 Bridgewater ® Daily Observations 02/23/2006 Bridgewater® Daily Observations February 23, 2006 © 2006 Bridgewater Associates, Inc. (203) 226-3030 Bob Prince Jason Rotenberg United States Labor dynamics and Fed policy: Revised 3/10/2006 The U.S. economy is continuing its transition into the late-cycle - that portion of the economic cycle when the tradeoff between economic growth and inflation is most acute. Since the Fed’s mandate is to “promote maximum employment with stable prices”, they are now particularly sensitive to labor market conditions because their mandate is particularly oriented toward employment markets. If for example, spending and output were strong but labor markets were weak and there was little threat of inflation, the Fed’s mandate would direct them to stimulate the economy in order to bolster employment. But if employment is strong and inflation is a threat, the Fed’s mandate would direct them to tighten, even if spending and output growth are modest. Since wage rates play a significant role in driving core inflation rates, and employment conditions impact wage rates, labor market conditions also impact the Fed’s view of inflation. Therefore, in directing monetary policy, the Fed has a greater orientation towards employment conditions than towards overall economic growth or spending, or even towards reported inflation. This is because they operate on the basis of expected inflation and employment conditions influence expected inflation. Given these dynamics, the level of growth is less important to the Fed than the composition of growth. More specifically, the Fed considers output and spending in the context of how that output is supplied. The more that output is supplied by rising productivity, the less concerned the Fed is. The more that output is supplied by a) increased hiring in the context of b) a thin labor supply, the more sensitive the Fed will be to increases in demand. Today with each passing month, we are digging deeper into an increasingly thin labor market. GDP growth has slowed a bit since the Fed began tightening in 2004, but productivity has fallen even faster. This means that today’s lower level of growth is putting more strain on the labor markets than the higher level of growth that existed prior to 2004.
  • -4% -2% 0% 2% 4% 6% 8% 10% 70 72 74 76 78 80 82 84 86 88 90 92 94 96 98 00 02 04 06 US Productivity Grow th (plus constant) US GDP Grow th Grow th slow ing, but productivity slow ing faster. The difference between GDP growth and productivity growth represents the degree to which output is supplied by increased hiring. Therefore, it is no surprise that the differential between GDP growth and productivity growth is roughly the same as employment growth. -4% -2% 0% 2% 4% 6% 8% 70 72 74 76 78 80 82 84 86 88 90 92 94 96 98 00 02 04 06 Grow th Minus Productivity Employment Grow th Wages represent the price of labor, which is driven by basic forces of supply and demand. If the demand for labor is rising faster than the supply of labor, while the supply is limited, the price of labor will rise, and vice versa. Given domestic supply/demand conditions, we would normally be seeing rising wage rates. But the supply of labor is increasingly global and the competition from emerging market labor is keeping wage rates lower than they otherwise would be. Still, if domestic employment conditions are strong, this means that people are being hired despite the competition from abroad. This will ultimately cause an upward trend in domestic wages. However, the trend will be muted until the dollar falls and foreign exchange rates rise enough to reduce the relative cheapness of foreign labor. Late-cycle conditions will cause the Fed to be more sensitive to a decline in the dollar, because this will reduce imported wage deflation and will reduce the competitive pressures that are holding down U.S. wages. 2 Bridgewater ® Daily Observations 02/23/2006
  • 1% 3% 5% 7% 9% 11% 70 72 74 76 78 80 82 84 86 88 90 92 94 96 98 00 02 04 06 -3% -2% -1% 0% 1% 2% 3% 4% Yearly Change in the Unemployment Rate (inverted) Nominal Wage Grow th (left scale) Upw ard pressure Given today’s late-cycle conditions, initial claims for unemployment are a particularly useful barometer of the pressures on Fed policy. This week’s initial claims were 278 thousand, i.e. low again. As shown below, this measure is a virtual leading proxy for the unemployment rate and portends tighter labor markets ahead. 3% 4% 5% 6% 7% 8% 86 88 90 92 94 96 98 00 02 04 06 0.15% 0.20% 0.25% 0.30% 0.35% 0.40% Unemployment rate Initial Claims Deflated by Labor Force Stronger and tighter labor markets 3 Bridgewater ® Daily Observations 02/23/2006
  • Looking farther ahead, corporate America has plenty of money available to continue hiring. -3% -2% -1% 0% 1% 2% 3% 4% 5% 6% 70 72 74 76 78 80 82 84 86 88 90 92 94 96 98 00 02 04 06 -30% -20% -10% 0% 10% 20% 30% 40% 50% 60% Employment Grow th Profit Grow th (lag 12 mos) Plenty of money available for hiring These late-cycle labor dynamics are unfolding in classic fashion. And the market action is classically late-cycle as well. Market pricing reflects discounted economic scenarios. And the composition of market pricing across all markets provides a picture of what type of economic environment is discounted in prices. The following dial shows that current market pricing is perfectly consistent with a late-cycle dynamic. Over the past year, this dynamic has moved clockwise, deeper into the late- cycle. MarketActionCycleIndication 2/22/2006 2/22/2005 EconomicTrough Mid-Cycle Late Cycle / Early Recession Early Recovery 4 Bridgewater ® Daily Observations 02/23/2006
  • 5 Bridgewater ® Daily Observations 02/23/2006 Bridgewater Daily Observations is prepared by and is the property of Bridgewater Associates, Inc. and is circulated for informational and educational purposes only. There is no consideration given to the specific investment needs, objectives or tolerances of any of the recipients. Recipients should consult their own advisors, including tax advisors, before making any investment decision. This report is not an offer to sell or the solicitation of an offer to buy the securities or other instruments mentioned. Bridgewater research is based primarily upon proprietary analysis of current public information from sources that Bridgewater considers reliable, but it do not assume responsibility for the accuracy of the data. The views expressed herein are solely those of Bridgewater as of the date of this report and are subject to change without notice. The views represent Bridgewater's outright views in these specific markets, but not all markets that Bridgewater trades. Bridgewater may have a significant financial interest in one or more of the positions and/or securities or derivatives discussed. Those responsible for preparing this report receive compensation based upon various factors, including, among other things, the quality of their work and firm revenues.