US labour productivity has improved further amid moderating price pressures and a normalising labour market, underpinning investor expectations of more interest rate cuts in 2025. However, markets have scaled back their estimates of the number of cuts as investors worry about the impact on the US economy – and inflation – of the impending ‘Trump import tariffs’.
Measuring how efficiently the US converts inputs such as labour and materials into goods and services, productivity data compares output growth and the rise in hours worked. Data shows non-farm productivity rose by 2.2% in the third quarter as output increased by 3.5%, but hours worked by only 1.2%. Unit labour costs were up 1.9% – slower than the 3.4% increase over the last four quarters.
This continued rebound in productivity underpins the US Federal Reserve’s ‘comfort’ with regard to developments on the inflation front. Chair Jerome Powell has repeatedly stated his confidence that core inflation can be gradually brought back down to the Fed’s 2.0% target.
The question now is whether the imposition of significant and comprehensive tariffs will derail the rate cut story.
Tariffs are typically inflationary in the short term (from a few months to a year after implementation) as they impact an economy’s efficiency and impose costs on consumers and producers. In the long run, they can be expected to be deflationary.
We think the Fed should be able to look through the transitory shock of any tariffs as long as consumers’ and producers’ inflation expectations remain anchored.
The Fed can be expected to resume cutting rates once any deceleration in the economy becomes pronounced. In this case, stocks and bonds would suffer in an initial shock, but recover when the rate cut cycle kicks off again.
