Viewpoint
January 09, 2026 | 15:53
Pointing Towards More Resilience
Economics
Economics
Economics
Economics
Economics
Economics
Economics
Economics
Pointing Towards More Resilience |
| A lot has happened since you went away on holiday. Buffeted by tariffs, elevated inflation, deteriorating job growth, and now a sharp rise in health insurance premiums for many Americans, it’s easy to imagine the economy will only get worse from here. The New York Fed’s Survey of Consumer Expectations for December, released this week, highlights these fears. The mean probability of finding a job in the next three months sank to a fresh record of 43.1%, well under its pandemic low of 46.2% (Chart 1). Consumers also reported a surge in the mean probability of missing a minimum debt payment over the next 3 months to 15.3% from 13.7% in November. This likely reflects the increasing financial burden of sharply rising health care premiums under the ACA and dwindling household savings (Chart 2). Note that real disposable personal income growth was nearly unchanged in the third quarter (Chart 3) and the personal savings rate slipped to 4.0% in September, from 5.5% as recently as April. Normally, these signs of consumer and financial angst, dwindling savings, and labor market deterioration would be enough to conclude that the economy was due for a sharp slowdown and even at risk of recession. |
| But that’s not the message coming from the latest GDP, productivity, and trade data. Real GDP and productivity just put in their best six-month string of growth since the second half of 2023. Productivity posted stellar back-to-back quarterly gains of 4.1% a.r. in Q2 and 4.9% in Q3, while GDP growth picked up to 3.8% in Q2 and 4.3% in Q3. GDP growth from a year ago unexpectedly accelerated to 2.3% from 2.0% in the first three months of the year—well above the long-term potential, estimated at 1.8% by the Fed. We forecast the year-on-year GDP growth rate to rise to 2.4% in 2025Q4 and move above 3.0% in 2026Q1. In short, the economy appears to still be operating well above its optimal speed limit that would keep inflation risks in check. As of the third quarter, real GDP was still about $515 billion above its potential growth path as estimated by the Congressional Budget Office (Chart 4). Fourth quarter GDP growth is looking a lot healthier now too. For the second week in a row, we are lifting our estimate for Q4 GDP, now to 2.1% annualized from 1.3% last week. The October trade report saw the smallest trade deficit since 2009, and real imports will likely drop at over a 10% annualized pace in the fourth quarter with net exports alone adding around 1.8 percentage points to Q4 GDP growth. The economy is well positioned to maintain a similar growth rate or better over the rest of 2026. GDP growth year/year is forecast to improve to 2.5% in 2026 from 2.2% in 2025. Fiscal and monetary policy is turning more accommodative this year. The OBBBA alone is expected to lift real GDP growth by at least 0.3 percentage points. As robust growth continues, the labor market should soon stabilize with modest monthly job gains and a steadier unemployment rate. The AI investment boom and stronger productivity gains should support continued business investment, solid profits, and nominal hourly earnings growth. Adding to the upside risks around the 2026 housing market. The President ordered Fannie Mae and Freddie Mac to buy $200 billion in mortgage bonds to help bring down mortgage rate spreads and improve housing affordability. While it doesn’t rise to the level of a new Fed QE program, it does have the potential to squeeze mortgage rate spreads, according to some analysts by as much as 20 to 25 basis points. Mortgage-Backed Securities rallied on the news with spreads over the ten-year Treasury narrowing sharply by nearly that amount, around 18 basis points already. This should help keep mortgage rates contained near-term even if more inflation, rising deficits, or a stingy Fed start to push Treasury yields higher. On the other hand, it puts us on high alert for further politically motivated economic policy changes that may be rolled out in the weeks ahead to try and bolster growth before the mid-term elections. Moreover, a firming, and above-potential, growth outlook for 2026 could present some problems for the next Fed Chair and doves on the FOMC that are looking for any reason to further cut rates. |
A Cornucopia of Labor Market Metrics |
| Owing to turn-of-the-year calendar quirks and the release of a shutdown-postponed report, this week’s volume of government and private sector labor market data was unparalleled. The marquee release was the BLS’ report on the Employment Situation for December. Payroll employment expanded 50k, and there were 76k of net downward revisions to the prior two months (mostly for October, when the federal government’s separation program was accounted for). Private sector payrolls were up 37k, with the three-month average (29k) posting its seventh straight month in the sub-60k range. Household-surveyed employment was up 232k, comparable to August and September (October’s survey was canceled). The unemployment rate dipped to 4.4% from 4.5% in November, which was revised down from 4.6% owing to annual (seasonal adjustment) revisions. The risk of triggering the Sahm Rule again was not realized (the three-month average being at least 0.5 ppts above its minimum of the past year). This was last triggered in July-September 2024, which was a false recession signal but still likely contributed to the Fed’s surprise 50-bp inaugural rate cut. The BLS’ (delayed) Job Openings and Labor Turnover Survey (JOLTS) for November showed vacancies down 303k to 7.15 mln, which was below the number of unemployed people (7.78 mln). The job-openings-to-unemployment ratio had been below 1 in three of the past four months (not including October’s canceled figure). The ratio topped 2 during peak labor shortages in 2022. The JOLTS’s other major ratios were revisiting multiyear extremes (apart from the three months at the onset of the pandemic). The job openings rate dropped 2/10s to 4.3%, matching the lowest level since December 2019. The hires rate also dropped 2/10s to 3.2%, matching its lowest level since January 2011. And the quits rate inched up 1/10 to 2.0%, oscillating between 1.9% and 2.0% for the fourth consecutive month (October matched the lowest mark since December 2014). On the private sector side, the employment measures in the Manufacturing and Services PMIs both improved in December. While the former (at 44.9) remained in contraction territory for the 11th consecutive month (since the tariff rubber hit the road), the services measure drove back into expansion land (52.0) for the first time in seven months. The ADP National Employment Report showed a 41k increase in private payrolls in December after a 29k decrease in November, continuing the oscillating pattern in place since the data noticeably slowed in May. The ups have been offsetting the downs, modestly, for a monthly average gain of 17k. Revelio Labs’ measure of total employment rose 71k in December, up from 32k in November and just 1k shy of matching a 13-month high. Bottom Line: These individual data prints paint a consistent picture of the labor market. It has slackened and weakened meaningfully from its multigenerational extreme degree of tightness a few years ago, and a gradual slowing trend persists. However, some of the recent softness seems to be non-cyclical, reflecting changes in immigration policy along with the dispersion of AI and other technological changes that may be stoking productivity growth (see Sal’s Thought, “Productivity Rebirth”). And with inflation still sticky, 2026 should herald a more cautious Fed. |
Productivity Rebirth |
| Labor productivity among American businesses continues to impress, accelerating 4.9% annualized in Q3. That was the fastest rate in two years and followed an already-strong 4.1% advance in the prior quarter. True, the increase is less striking on a yearly basis (1.9%). However, quarterly and even yearly data are volatile, making it necessary to smooth results over a longer period to discern a trend. Looking at the yearly change in the eight-quarter moving average yields an above-normal 2.4% pace (Chart 1). Although not in the same league as the stellar 3%-plus gains seen earlier this century after the widespread rollout of the internet, growth is above the past-decade average (1.8%) and the post-war norm (2.2%). The smoothed rate is lower in manufacturing (0.7%), though this sector is starting to stir. Factory productivity quickened 3.3% annualized in Q3 and is up a solid 2.3% in the past year, after contracting for much of the past decade. In Q4, business-sector productivity growth likely moderated but remained decent, given little rise in work hours. |
| The impressive productivity performance likely reflects two factors. First, companies are in cost-cutting mode, seeking to improve efficiencies while hiring fewer workers. This likely stems from a combination of past elevated inflation and new tariffs, which have strained the spending power of lower-income households. Second, companies are testing new AI systems and automation, and don’t want to get left behind if reality matches the hype. If AI adoption can sustain robust productivity gains, the implications are numerous and generally positive. The main drawback, at least initially, would be continued weak job growth and modest wage gains as companies hesitate to hire and workers delay seeking pay increases. |
But the flip side of a soft labor market is lower inflation. Growth in hourly compensation moderated to 3.2% y/y in Q3, the slowest in more than two years. Combined with the productivity surge, this led to unit labor costs contracting for a second straight quarter and rising just 1.2% in the past year. The latter implies little upward pressure on inflation, opening the door for several more Fed rate cuts this year. Lower interest rates, in turn, would support the economy and eventually job creation. Moreover, with immigration restrictions and an aging population sapping the workforce, productivity might become the primary driver of GDP growth for some time. The income, earnings and wealth generated from a productivity revival should also lead to new jobs in the future, though many may not be in current occupations. This would be a win-win for consumers and shareholders, and eventually workers. |