Stocks & Bonds Rally Despite Weak Productivity Report

Go figure: Stocks & bonds sold off on Tuesday following a hotter-than-expected Q1 Employment Cost Index (ECI). It was up 5.4% q/q (saar) and 4.1% y/y. Today, they both rallied despite a hot Q1 unit labor costs inflation report. We agree with the markets' response to today's news because it is consistent with our view that inflation is still moderating when measured on a y/y basis.

Unit labor costs (ULC) is simply hourly compensation divided by productivity. It is the most important measure of the underlying inflation rate in the labor market and is highly correlated with the CPI inflation rate when both are measured on a y/y basis (chart). ULC inflation was actually down to 1.8% y/y during Q1, suggesting that consumer price inflation could fall to 2.0% in coming months.