Room for the Fed to Duck and Cover

Two key pieces of data were released this morning that will give the Fed room to lower interest rates in the first quarter of 2007. Productivity was better than expected for the last two quarters and unit labor costs were lower. This is exactly what we are looking for in a soft landing scenario that will allow the Fed to lower rates before they choke off economic expansion.

Productivity Grows 0.2%
As Labor Costs Revised Lower

"WASHINGTON -- U.S. productivity growth was mildly stronger during the summer than first thought, while unit labor costs were revised sharply lower for two quarters in a favorable sign for inflation.
Nonfarm business sector productivity increased 0.2% during July through September, the Labor Department said Tuesday. Originally, Labor said productivity was unchanged during the third quarter.

Wall Street expected an upward revision in productivity for the third quarter -- but a bigger one. The median estimate of 23 economists surveyed by Dow Jones Newswires was productivity rising at a 0.5% annual rate.
There was an unrevised 1.2% increase in second-quarter productivity, which is output divided by hours worked.

Third-quarter unit labor costs -- a gauge of inflationary pressures -- rose by 2.3%. Economists expected a 3.2% advance. Labor originally estimated a 3.8% increase for the third quarter. Unit labor costs in the second quarter decreased, falling 2.4%; originally, Labor reported a 5.4% surge.

Compared to a year earlier, unit labor costs were 2.9% higher; in Labor's last productivity report, it estimated the year-over-year climb at 5.3%. Unit labor costs are the compensation paid to labor for one unit of output. Labor is considered the most important input cost to production. Higher labor costs must be either passed through by a company in the form of higher prices to its customers or absorbed in the firm's profit margins.

The Federal Reserve watches unit labor costs to weigh inflationary pressures within the economy. At their last meeting, bankers held the target for the federal funds rate at 5.25%. Economic growth has been cooling. Whether the Fed might lower rates to compensate for slowing growth hinges on their outlook for inflation."

By JEFF BATER - WSJ
December 5, 2006 9:00 a.m.