Andrew Cates

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It's always tough to generalise about emerging market (EM) economies. Even knowing if they are emerging economies can be tricky as they are classified in different ways by different organisations. China's role and relative dominance in world trade and financial market flows in recent years has arguably further complicated matters not least given the underlying exposure of many smaller emerging economies to that trade and to those flows.

Rightly or wrongly, however, many observers of the global macro scene wish to understand how this aggregate grouping of EM economies are evolving, how they are coping with the COVID crisis and what their outlook might be? In this brief commentary we offer some perspective on these issues.

In summary, with the notable exception of China, the crisis is far from over for most EM economies. The underlying economic backdrop for most has been weak and a recovery in recent months has so far been fragile or elusive. While fiscal and monetary policy support have often been impressive, that has still exposed some debt-related vulnerabilities. Absent more solid foundations for income generation – and firmer export growth in particular – those vulnerabilities could weigh more heavily on the economic outlook in the period ahead.


&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;Figure 1: Structural weakness in EM trade&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;Figure 2: EM current account balance has dipped into deficit territory 
<a href="/comment/201005t1.png" name="modal"><img class="small" src="https://haver-commentaries.s3.eu-west-1.amazonaws.com/comments/201005t1.png"></a>
 <a href="/comment/201005t2.png" name="modal"><img class="small" src="https://haver-commentaries.s3.eu-west-1.amazonaws.com/comments/201005t2.png"></a>


Figure 3: Weak EM growth has led to a sharp deterioration in government finances 
<a href="/comment/201005t3.png" name="modal"><img class="small" src="https://haver-commentaries.s3.eu-west-1.amazonaws.com/comments/201005t3.png" align="left"></a>
Fragile foundations 

The underlying backdrop for many emerging market economies before the current COVID crisis made a mark was weak. We explored some of the issues in a post on Asia a few weeks ago (see <a href="http://www.haver.com/comment/comment.html?c=200827SP.html">Asia's De-globalisation Nightmare and Covid-19</a>) but they are worth re-stating because they apply to other emerging regions too. They concern a sharp structural erosion of export income flows and a commensurate deterioration from surplus to deficit in the aggregate current account balance (see figures 1 and 2 above). Partly because of this public finances have also been drained as economic growth has slowed. And this has meant that fiscal space has been severely depleted in recent years as well (see figure 3). Public debt ratios in the meantime have been climbing as a result.



Modest recovery from hefty Q2 contraction 

Against this rather sobering backdrop the current COVID crisis could not have come at a worse time. Indeed the impact on economic activity in many EM countries has so far been wretched. In figure 4 below we illustrate the quarterly change in GDP in Q2 for those large EM economies where the data are available. With the notable exception of China, every country on our list experienced an economic contraction and typically a very large economic contraction. China is an outlier in experiencing an advance simply because the worst of the virus and lockdown policies had unfolded in Q1 and the unwinding of these policies allowed a recovery to unfold in Q2.


&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;Figure 4: GDP growth in Q2 collapsed in most major EM economies 

<a href="/comment/201005z4.png" name="modal"><img class="small" src="https://haver-commentaries.s3.eu-west-1.amazonaws.com/comments/201005z4.png"></a>

&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;Source: National sources/Haver Analytics


Figure 5: EM industrial production has been slow to recover 
<a href="/comment/201005t5.png" name="modal"><img class="small" src="https://haver-commentaries.s3.eu-west-1.amazonaws.com/comments/201005t5.png" align="left"></a>
Most of these economies have recovered some poise in more recent months. But high frequency indicators such as industrial production and retail sales growth are still languishing well below pre-COVID levels (see figure 5).

Testing times with COVID 

Meanwhile with one or two exceptions – and China is again one of them – the latest data that concern COVID-19 in these economies do not look that healthy either. Case numbers per million of the population are often high (and rising) as are the positive rates from current testing for some (see figures 6 and 7 below).
 

&nbsp;Figure 6: COVID-19 case numbers per million population&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;Figure 7: The Positive Test Rate in Emerging Market Economies 
<a href="/comment/201005z6.png" name="modal"><img class="small" src="https://haver-commentaries.s3.eu-west-1.amazonaws.com/comments/201005z6.png"></a>
 <a href="/comment/201005z7.png" name="modal"><img class="small" src="https://haver-commentaries.s3.eu-west-1.amazonaws.com/comments/201005z7.png"></a>
&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;Source: Oxford University/Haver Analytics&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;Source: Oxford University/Haver Analytics 


Policy response often impressive 

Policymakers have responded to the crisis with a plethora of support measures with both fiscal and monetary policy playing prominent roles. Brazil, South Africa and China in particular stand out on the fiscal front. Turkey also stands out with an impressive degree of liquidity support via loans, equity injections and guarantees (see figure 8 below).


&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;Figure 8: EM fiscal responses to COVID-19 

<a href="/comment/201005z8.png" name="modal"><img class="small" src="https://haver-commentaries.s3.eu-west-1.amazonaws.com/comments/201005z8.png"></a>

&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;Source: IMF/Haver Analytics


As for monetary policy, short-term interest rates have been lowered quite significantly in many countries. But thanks to large capital outflows government bond yields in many countries jumped sharply as the virus first began to circulate while exchange rates often depreciated sharply as well (see figures 9 and 10 below). And this has complicated efforts to provide policy assistance not least - as we discussed above - because there is not that much leeway to provide too much stimulus from fiscal policy.


&nbsp;Figure 9: Lower policy rates in EM, but higher long-term rates&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;Figure 10: Weaker exchange rates in EM 
<a href="/comment/201005t9.png" name="modal"><img class="small" src="https://haver-commentaries.s3.eu-west-1.amazonaws.com/comments/201005t9.png"></a>
 <a href="/comment/201005t0.png" name="modal"><img class="small" src="https://haver-commentaries.s3.eu-west-1.amazonaws.com/comments/201005t0.png"></a>


Unconventional monetary policy in play 

This has meant though that many EM central banks have turned to unconventional monetary policy in order to both fend off financial instability and shore up their economies. Specifically 16 EM central banks have announced that they are either ready to engage in government bond purchases (i.e. quantitative easing programmes - QE) or have already done so.

To be fair this bout of monetary easing via either conventional interest rate levers or QE (or both) appears to have met with some modest success. In figure 11 below we show the credit impulse indicators - showing the flow of new credit from the private sector - that we have recently launched (and which can be sourced from our EMERGE database) for a number of emerging market countries. Latest data for Q2 2020 suggest a stronger credit impulse has unfolded of late and particularly in China. Importantly, however, that's not a generic conclusion that one can make for all EM economies. The likes of Indonesia, South Africa and most notably India (given its relative size) faced a negative credit impulse in Q2 notwithstanding the pursuit of QE programmes.


&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;Figure 11: Credit impulses are in positive territory in many EM economies 

<a href="/comment/201005x1.png" name="modal"><img class="small" src="https://haver-commentaries.s3.eu-west-1.amazonaws.com/comments/201005x1.png"></a>

&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;Source: National sources/Haver Analytics


Despite this near-term success for some EM economies, however, and for China in particular, the outlook for many EM economies remains challenging. Aside from the obvious issues that concern the virus and the healthcare policies that are required to control it, there are a number of obstacles to a trouble-free economic existence in the coming months. They concern, in part, the era of de-globalization in which the world economy now finds itself and the consequence of this, namely a lack of export income generation. The absence of that income has already allowed growth to be fuelled by more debt accumulation. And thanks to the virus and the economic policies that are being pursued to stifle its impact, further debt accumulation is inevitable in the period ahead with potential ramifications for capital flows. The sustainability of this together with its potential for generating inflation side-effects will arguably now hold the key for the economic and financial market outlook in many of these countries in the period ahead.


Viewpoint commentaries are the opinions of the author and do not reflect the views of Haver Analytics.
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It's always tough to generalise about emerging market (EM) economies. Even knowing if they are emerging economies can be tricky as they are classified in different ways by different organisations. China's role and relative dominance [...]

Emerging Markets and COVID-19

Charles Steindel

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Unsurprisingly, all states (as well as DC) saw double-digit rates of decline in real GDP decline in the second quarter. The range was wide, varying from DC's -20.4 percent to Hawaii and Nevada's -42.2. In general, the declines were larger in more industrialized states, states more heavily dependent on travel and tourism (as Hawaii and Nevada clearly illustrate), and states which had longer and stricter lockdowns. In general, states in the Northeastern quadrant of the nation saw larger declines than those elsewhere. Delaware and Utah stood out for “modest” rates of declines (respectively, 21.9 and 22.4 percent). Tennessee was an anomaly on the other ends, with a 40.4 percent rate of decline in a state one would not think of as very dependent on travel. However, the drop in travel-related sectors was exceptionally large in the Volunteer State.

Most likely, all—or virtually all—states experienced double-digit rates of growth in the third quarter. An interesting question will be if any fully reversed the declines in the first half of the year.

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Unsurprisingly, all states (as well as DC) saw double-digit rates of decline in real GDP decline in the second quarter. The range was wide, varying from DC's -20.4 percent to Hawaii and Nevada's -42.2. In general, the declines were [...]

State GDP in 2020:Q2

Kelvin Ho-Por Lam

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The decline in Hong Kong retail sales volume eased to -13.4% y/y in August compared to the 23.8% y/y drop in the previous month, declining for the nineteenth consecutive month. Although retail trade still suffered from double digit annual falls, the trend seems to be stabilising somewhat. On a 3m/3m basis, August saw an improvement of 12.3%, suggesting that the worst may be behind us (see Figure 1).

In value terms, retail sales fell by 13.1% y/y compared to -23.1% y/y the month before. The breakdown revealed that tourism related spending remained to be the largest drag on headline growth, detracting -9.9 pp. from the annual rate in August. It is interesting to see that despite the ongoing social distancing measures, a subset of discretionary spending was marginally stronger, with our proxy of household items sales adding to overall growth (0.9 pp.) for the first time since Q4’18. Our measure of household items include electrical goods, furniture and other consumer durable goods. Perhaps the helicopter money distributed by the government earlier did alleviate the dire situation in the retail trade at the margin (HK$10k was given to every Hong Kong resident as part of the government anti-pandemic stimulus). Nevertheless, with the jobs market still in moribund, overall domestic demand stayed weak, shaving almost 4 pp. from headline growth (see Figure 2).


Figure 1: The fall in retail sales volume continued in August&nbsp;&nbsp;Figure 2: Retail sales value: Contribution to annual growth (pp.) 
<a href="/comment/201001z1.png" name="modal"><img class="small" src="https://haver-commentaries.s3.eu-west-1.amazonaws.com/comments/201001z1.png"></a>
 <a href="/comment/201001z2.png" name="modal"><img class="small" src="https://haver-commentaries.s3.eu-west-1.amazonaws.com/comments/201001z2.png"></a>

&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;Source: Census and Statistics Department, Haver Analytics&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;Source: Census and Statistics Department, Haver Analytics 


Taking a closer look at tourism related spending which accounts for a large chunk in total sales, the share came in at just 19.7% in August, sharply lower than the 5-year average of 31.2% prior to the Covid-19 pandemic. Indeed, border shutdown and mandatory quarantine measures had caused inbound Chinese tourist arrivals to plunge to just a total of 2.7 million since the start of the year (see Figure 4), in stark contrast to the 34.5 million witnessed over the same period last year. Figure 3 shows the composition of our tourism spending proxy, of which, sales of luxury goods (jewellery, watches and clocks and value gifts) remained a major drag on tourism related sales, followed by medicines and cosmetics. Note that sales of medicines and cosmetics could have been even weaker, were it not buoyed by local demand for PPEs against Covid-19.



&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;Figure 3: Luxury goods is the largest drag on tourism related sales 

<a href="/comment/201001z3.png" name="modal"><img class="small" src="https://haver-commentaries.s3.eu-west-1.amazonaws.com/comments/201001z3.png"></a>

&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;Source: Census and Statistics Department, Haver Analytics


&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;Figure 4: Chinese tourist arrivals have plunged since the pandemic began 

<a href="/comment/201001z4.png" name="modal"><img class="small" src="https://haver-commentaries.s3.eu-west-1.amazonaws.com/comments/201001z4.png"></a>

&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;Source: Hong Kong Tourism Board, Haver Analytics


However, there is one bright spot in August’s data, supermarket sales have been mostly growing at double-digit pace since January. This is because various anti-pandemic measures have led to people dinning more at home. In August, supermarket sales value grew by 13.9% y/y, slowing from 24.1% y/y a month ago.

In a nutshell, we think protracted weakness in the labour market coupled with political uncertainty will hamper retail sales growth in the near term. A potential flare up of the virus during the winter months will only increase the downside risks to both domestic and tourism demand for retail goods. The Census and Statistics Department will release GDP estimate for Q3 on 30th October. Previously, we saw a conspicuous fall in private consumption in Q2, Q3’s print is likely to remain weak but less negative. While we think the softer rate of decline in retail sales growth in recent months point to a less fragile performance in household consumption, we also think there is a new normal of shopper’s behaviour that emerged during the pandemic. This may have supported overall private consumption growth, with local spenders becoming more familiar with online shopping and struggling businesses gradually shifting to online platforms in their quest for survival.


Viewpoint commentaries are the opinions of the author and do not reflect the views of Haver Analytics.
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The decline in Hong Kong retail sales volume eased to -13.4% y/y in August compared to the 23.8% y/y drop in the previous month, declining for the nineteenth consecutive month. Although retail trade still suffered from double digit [...]

Retail Sales (August 2020): Retail Sales Fall at Milder Pace in August

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Joseph G. Carson

The widely followed employment cost index (ECI) jumped 1.2% in Q1 2024, faster than the 0.9% increase in Q4 2023, raising fears that labor costs are re-accelerating. As big as the jump in the ECI was in Q1, another labor cost measure (ECEC) shows employee costs are rising even faster.

The Bureau of Labor Statistics, the government agency in charge of reporting labor market data, provides two crucial measures of employee costs: the employment cost index (ECI) and employer costs for employee compensation (ECEC). Both measures, with a similar scope covering 5500 to 5600 private industry establishments and 23000 occupational observations, play a pivotal role in labor cost analysis. However, it's important to note that the ECI excludes employment shifts among occupations and industries, while the ECEC does not, making the ECEC an equally important comprehensive measure of total current employment costs.

The two measures are simple to understand: the starting point for both measures is the change in wages, but if people move to higher-paying jobs or shift occupations because of the promise of higher pay, the ECEC measures will grow faster than the ECI. In contrast, if the opposite is true, when the jobless rate is high, job openings are low, and people have to accept lower-paying jobs, the ECI would increase faster than the ECEC.

In the last several years, the labor market has been characterized by a record number of job openings, which have encouraged people to shift industries and occupations in search of higher pay. The labor cost data confirms this did happen. Private industry wage costs in the ECEC have outpaced the increases in the ECI every year, and the increase in 2023 of 6.9% was the largest on record and 270 basis points over the increase in the ECI.

The Q1 2024 report for ECEC is due on June 18. Based on the still high number of job openings and low jobless rate, the Q1 rise in the ECEC index should exceed the ECI increase, adding to current fears of higher labor costs feeding into inflation numbers.

How Fast Are Labor Costs Rising?  Faster Than You Think

Ken Matheny

**The US economy is stronger than suggested by the “soft” 1.6% increase in GDP in the first quarter, while a sharp upturn of inflation puts Fed rate cuts on hold for at least several months.**

**Look to final sales to private domestic purchasers, not GDP, for a better indication of the economy’s underlying strength.**
The initial (“advance”) report of the national accounts for the first quarter of 2024 should be interpreted carefully.  Looking beyond the headline figures, the economy’s underlying growth momentum was notably stronger than the disappointing figure of 1.6% quarterly GDP growth in the first quarter.  GDP growth was held down by declines in components that tend to be more volatile  --- inventories and net exports --- in contrast to solid growth in other components, including consumer spending and private investment.  Personal consumption expenditures (PCE) posted solid growth (of 2.9%).  Business fixed investment also rose 2.9%, while residential investment jumped 13.9%, continuing a recovery that began in the second half of 2024.

A more telling indicator of the US economy’s underlying strength is final sales to private domestic purchasers, which rose at a solid 3.1% annual rate in the first quarter, virtually identical to increases in the third and fourth quarters of 2023 of 3.0% and 3.3%, respectively.  This is a clear if preliminary indication that the economy retains solid momentum for growth.

Together, declines in inventory investment and net exports subtracted 1.2 percentage points from GDP growth in the first quarter, but those components are not likely to continue to subtract large amounts from GDP growth on an ongoing basis, even though quarterly swings could be significant (in either direction) from time to time.  The level of inventory investment ($35 billion in the first quarter) is broadly sustainable, suggesting that repeated large declines are not the most likely outcome.  Net exports have been in a sideways waffle since the second half of 2022.  Future large declines are possible if foreign demand were to collapse or the dollar were to appreciate sharply, but neither of those outcomes appear to be highly likely at this juncture.  In short, the 3.1% growth in final sales to domestic purchasers is a better indicator of underlying strength in demand than the smaller 1.6% increase in GDP in the first quarter.

Of course, GDP and other estimates are subject to revision, so the picture of first-quarter growth could be altered in coming months.

**Inflation surged in the first quarter, nearly eliminating any prospect for a Fed rate cut prior to this fall.**
Another major component in today’s report on the national accounts was a disturbing increase in consumer inflation.  The price index for personal consumption expenditures (PCE) rose at a 3.4% annual rate in the first quarter, the largest increase since the first quarter of 2023.  Meanwhile, the core PCE price index rose at an even higher 3.7% annual rate in the first quarter, far above the increase of 2.0% in the final two quarters of last year.  This is a direct challenge to any hope that the Federal Reserve will begin to lower interest rates in coming months.  As of the first quarter, the annual (four-quarter) increase in the core PCE price index was 2.9%.  It is likely that tomorrow’s report on monthly PCE will show annual (12-month) inflation at or slightly above February’s 2.8% reading.

The Federal Open Market Committee (FOMC) will almost certainly not begin to seriously contemplate rate cuts without clear indications that inflation is easing and well on track to fall to 2% over time.  The latest inflation figures suggest that progress on bringing inflation down has stalled.  It will take more than one or two “good” monthly inflation reports to convince policymakers that it is appropriate to begin cutting interest rates.  This makes any rate cut prior to this fall a low probability outcome and adds to the risk that there might not be any Fed rate cut in 2024.

240425KM.jpg

First-Quarter 2024 National Accounts

The Federal Reserve Bank of Philadelphia’s state coincident indexes in March showed some moderate variance. Four states were down slightly from February. The largest increase was Arizona’s .8 percent; three other states (Iowa, Delaware, and Vermont) had gains of at least .5 percent. Over the three months since December, Massachusetts was up 1.9 percent, while 8 other states (scattered across the nation) rose more than 1 percent. Over the last 12 months, Massachusetts again led, with an increase of 4.9 percent, while New York’s 3.6 percent was a fairly distant second. 5 states were down over the period, with Montana’s slump continuing, with a loss of 3 percent.

The independently estimated national figures of growth over the last 3 months (.75 percent) may be a touch higher than the state estimates would have suggested, but the 12-month figure (2.9) percent) looks to be roughly in line with the state numbers.

State Coincident Indexes in March 2024

Viewpoints: October 2020

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Emerging Markets and COVID-19

State GDP in 2020:Q2

Retail Sales (August 2020): Retail Sales Fall at Milder Pace in August