Rising Productivity Shows Economy Remains Resilient

The jobs report closed last week with robust read outs of an official number that beat economist expectations. Below the surface, however, hours worked fell to levels often associated with recessions. This juxtaposition of more workers clocking fewer hours suggests that while employment figures are up, the quantity of work didn’t expand much.

GDP growth remains subdued, with estimates of 2.5% by sources like the Atlanta Fed. This indicates productivity gains account for almost all the economic growth. It's an important aspect to underline because productivity gains can drive sustained economic growth without igniting inflationary pressures. In fact, wages printed slightly higher than anticipated, but this is justifiable against a backdrop of rising productivity.

The jobs report solidified my view that the Fed will likely opt for a quarter-point rate adjustment in November. I've consistently argued the Fed's neutral rate should ideally sit around 3.5%, implying a reduction of about 125 basis points from the current levels by mid-next year.

I commented last week that the money supply data showed growth annualizing at a healthier 5% level. We receive weekly data on deposits at banks and that higher frequency datapoint also sent an encouraging sign showing money supply growing at levels consistent with 2-3% real growth and 2-3% levels of inflation. That is a positive reflection on the economic resilience.

Let's consider the bond market's reaction to all this data. The 10-year yield pushed towards 4%, a clear indicator of market sentiment expecting less chances of a recession. Many advisors told me they were trying to lock in long-rates now that the Fed is cutting—that has proven wrong, as I had warned, as long rates have gone higher, as should have been expected since the Fed’s move. And I think bonds are likely to decline again over the next six months as the Fed pivot lowers the probability of a downturn turn in the economy.

This lower probability of a recession is also good for equities, particularly the lower valued segments of the market like small caps which are very sensitive to recession fears. I can see 6,000 being a target that the S&P 500 hits, while also recognizing that 2025 will have more subdued returns than we’ve experienced in 2023 and 2024.

The ongoing dynamics in the Middle East continue to pose potential volatility for global markets, particularly in the commodities sector. Yet despite escalated attacks in the region, the impact on oil prices has been relatively muted. The United States achieved greater energy self-sufficiency over the last few decades compared to the 1970s and 1980s. Today, the U.S. is not only less reliant on Middle Eastern oil but also has robust domestic production capabilities that help buffer against supply disruptions. Saudi Arabia also commented that it has 2 million barrels per day production it will have to hike, and this is one reason why oil prices were relatively contained despite the escalated fighting.

Overall, the backdrop remains quite positive for equities. The Fed is on course for cutting five to six times by next summer, while the economy remains quite resilient.