Productivity Growth Moderates at the End of 2024

Nonfarm labor productivity increased at a 1.2% annualized rate in the fourth quarter. Smoothing through the quarterly noise, labor productivity rose 2.3% in 2024, an improvement from the 1.6% rise in 2023.

The more subdued reading on productivity growth in Q4 along with a pickup in compensation costs pushed up unit labor costs growth to a 3.0% annualized rate over the quarter. While this measure points to labor cost running a bit hot relative to the Fed’s 2% inflation goal, we take more signal from the medium-term trend in productivity growth and the Employment Cost Index, which makes labor costs look like less a threat to the Fed’s inflation objective.

The strong performance in 2024 has helped to lift productivity growth closer to its historical (post-WWII) average. Over the current business cycle (2019–2024), nonfarm labor productivity growth has averaged a 1.8% annual pace, a few tenths higher than the 1.5% pace averaged over the prior cycle (2007–2019) and a stone’s throw away from the economy’s long-term average of 2.1%.

The recent strength may reflect some catch up after anemic growth before the pandemic. Productivity was noticeably lackluster following the Great Recession, as the scars from the downturn depressed capital investment and weighed on the vibrancy of the labor market. The labor market’s normalization, combined with the prevalence of remote work and investment in labor-saving technologies since the pandemic, appear to have boosted the run rate of productivity growth in recent years.

The more subdued rate of productivity growth in the fourth quarter coincided with a pickup in compensation costs, which rose at a 4.2% annualized rate. As a result, growth in unit labor costs, which can be thought of as the productivity-adjusted cost of labor, strengthened to a 3.0% annualized rate over the quarter. When measured on a year-ago basis, the trend in unit labor costs has crept back up, and, having increased 2.7%, now looks a little strong relative to the Fed’s 2% target.

That said, given the short-term volatility in productivity and compensation costs from this report, we are cautious in taking much signal from the recent pickup. The steadier and more reliable Employment Cost Index continues to point to labor costs receding and, when measured against the current cycle’s trend in productivity, makes labor costs look less threatening to the Fed’s inflation goal.

 

AI CORNER

Tech Giants Double Down on Their Massive AI Spending

(…) Their comments in recent quarterly earnings reports showed the AI arms race is still gaining momentum despite investor anxiety over the impact of China’s DeepSeek and whether these big U.S. companies will sufficiently profit from their unprecedented spending spree.

Investors have been especially shaken that DeepSeek replicated much of the capability of leading American AI systems despite spending less money and using fewer and less-powerful chips, according to its Chinese developer. Leaders of the U.S. companies were unbowed, touting advances in their own technology and arguing that lower costs will make AI more affordable and grow the demand for their cloud computing services, which AI needs to operate.

“We think virtually every application that we know of today is going to be reinvented with AI inside of it,” Amazon Chief Executive Andy Jassy said on Thursday’s earnings call. (…)

“AI represents for sure the biggest opportunity since cloud and probably the biggest technology shift and opportunity in business since the internet,” Jassy said. (…)

“I think part of the reason we are so excited about the AI opportunity is we know we can drive extraordinary use cases because the cost of actually using it is going to keep coming down,” said CEO Sundar Pichai. (…)

“As AI becomes more efficient and accessible, we will see exponentially more demand,” Nadella said. (…)

“That’s generally an advantage that we’re now going to be able to provide a higher quality of service than others who don’t necessarily have the business model to support it on a sustainable basis,” he [Zuckerberg] said.

Nvidia CEO Jensen Huang is always steps ahead. Some of the things he said at CES 2025:

• “It started with perception AI — understanding images, words and sounds. Then generative AI — creating text, images and sound,” Huang said. Now, we’re entering the era of “physical AI, AI that can proceed, reason, plan and act.”
• In its early days, the concept of software as a product—abstract, yet highly valuable—was a revelation. Huang sees AI following a similar trajectory, only this time it is not software but “tokens”—the building blocks of AI—that are being produced.
  These tokens, generated by AI, represent a new form of output. “We are producing a whole bunch of digital versions of something very valuable we call intelligence,” he explained. Tokens can be reconstituted into language, video or images. Soon, he argued the world might even see tokenized robotic articulation, where robots can be told in natural language to perform tasks and behave in specific ways.
• The age of AI Agentics is here, a future driven by intelligent AI agents capable of assisting with tasks across industries. Huang called this emerging sector “a multi-trillion-dollar opportunity,” positioning Nvidia at the forefront of the movement. While generative AI excels at creativity and automation, Agentic AI functions more like a digital assistant, capable of handling workflows, problem-solving, and providing real-time support across industries, such as human resources, software engineering, and medicine.
• “AI agents are the new digital workforce,” he said, predicting that the different agents will change the way we work.
  “The IT department of every company is going to be the HR department of AI agents in the future.” Nvidia will one day have 50,000 employees and over 100 million AI assistants, Huang predicted. And he said every organization will be see a similar growth in AI workers. “There’s no question about it,” he said. “Whether it happens in your generation or it happens in the next generation. It will happen.”
• AI will be mainstream in every application for every industry.
• “AI learns not tools, but work,” Huang said. Unlike software tools designed for human use, AI can acquire skills, reason through complex problems and even collaborate with other AI systems to perform tasks autonomously. Historically focused on building tools—both hardware and software—the world is now seeing digital versions of intelligence.
  “We have this new industry on top of us that never existed before,” he said. “This is the beginning of a new industrial revolution.”
• Huang unveiled “Cosmos”, a new foundation model designed to advance physical AI, or AI that operates in the real world, such as autonomous vehicles or robotics. Cosmos generates synthetic data to train AI systems, accelerating their ability to navigate and adapt to real-world environments.
• Huang announced a partnership with Toyota to integrate Nvidia’s AI systems into the automaker’s autonomous vehicle development. “A trillion miles that are driven around the world each year, that’s all going to be either highly or fully autonomous,” Huang said. “I predict that this will likely be the first multi-trillion-dollar robotics industry.” Cosmos is part of Nvidia’s Omniverse expansion, supporting industrial applications in simulation, robotics, and autonomous systems.
• Top PC manufacturers and system builders are launching NIM-ready RTX AI PCs with GeForce RTX 50 Series GPUs. “AI PCs are coming to a home near you,” Huang said. “Every software engineer, every engineer, every creative artist — everybody who uses computers today as a tool — will need an AI supercomputer,” Huang said.
• Huang revealed that Project DIGITS, powered by the GB10 Grace Blackwell Superchip, represents NVIDIA’s smallest yet most powerful AI supercomputer. “This is NVIDIA’s latest AI supercomputer,” Huang said, showcasing the device. “It runs the entire NVIDIA AI stack — all of NVIDIA software runs on this. DGX Cloud runs on this.”

Huang’s CES 2025 keynote: https://youtu.be/k82RwXqZHY8

• Generative AI adoption outpaces prior technologies. (The Daily Shot)

Source: Gavekal Research

UAE Plans to Invest Up to €50 Billion In French Data Centers

A fund from the United Arab Emirates is planning to spend between €30 billion and €50 billion ($31.2 billion and $52 billion) on a new campus for data centers in France, according to French officials. (…)

In a joint statement on Friday, the countries said they would aim to build a facility dedicated to AI with one gigawatt of capacity. (…)

MGX, a $100 billion investment vehicle, is also involved in Project Stargate, the ambitious effort from SoftBank Group Corp. and OpenAI to spend $500 billion on data centers in the US. That initiative is aiming to construct around a dozen facilities with a gigawatt capacity each, Bloomberg News reported earlier.

Data centers and AI have been the centerpiece of the UAE’s strategy to diversify its economy and extend its political influence. In January, a Dubai billionaire pledged to spend $20 billion on data centers in the US. G42, an Abu Dhabi tech conglomerate, has announced major computing projects across the Middle East and Africa. (…)

The Drug Industry Is Having Its Own DeepSeek Moment It isn’t just artificial intelligence—Chinese biotechs are now developing drugs faster and cheaper than their U.S. counterparts

The biotech industry’s DeepSeek moment came last fall.

That is when Summit Therapeutics, backed by billionaire Bob Duggan, announced that its drug had outperformed Merck’s blockbuster therapy Keytruda in a head-to-head lung-cancer trial. Keytruda, a $30 billion-a-year immunotherapy juggernaut, is the bestselling drug in the pharma industry and has long dominated the market. So the prospect of a superior competitor was seismic. Even more remarkable: Summit had licensed the drug just two years earlier from a little known Chinese biotech called Akeso.

The news added billions of dollars to Summit’s market capitalization, catapulting it into biotech’s upper ranks despite having no approved drugs. While Summit’s drug still hasn’t received U.S. regulatory approval, the results were a watershed moment for the industry, underscoring the competitive threat emanating from China.

In 2020, less than 5% of large pharmaceutical transactions worth $50 million or more upfront involved China. By 2024, that number had surged to nearly 30%, according to DealForma. A decade from now, many drugs hitting the U.S. market will have originated in Chinese labs.

(…) just as DeepSeek built a formidable chatbot—allegedly on a lean budget with limited access to semiconductors—Chinese biotech companies are also scrappier, capitalizing on a highly skilled, lower-cost workforce that can move faster.

Additionally, companies can conduct clinical trials at a fraction of what they would cost in the U.S., while recent changes in the Chinese regulatory system have streamlined and accelerated the approval process to get a study started.

For now, much of China’s biotech innovation is incremental rather than groundbreaking. Many companies focus on improving existing drugs—tweaking the chemistry, enhancing efficacy or differentiating them in key ways.

But Chinese innovation is steadily improving and is already starting to disrupt the U.S. drug-development ecosystem.

(…) chief executives of large pharmaceutical companies are broadening their horizons. Why spend $10 billion acquiring a U.S. biotech with a mid-stage drug when a similar molecule can be licensed from China for a fraction of the price?

The red-hot obesity-drug market offers one example. (…)

Merck and AstraZeneca are two pharma companies looking for a way in, and both turned to China for earlier stage orals under development. In late 2024, after scouring the market for obesity assets—presumably eyeing U.S. companies like Viking Therapeutics, which trades at a market value of around $3.7 billion—Merck chose to license an oral GLP-1 drug from China’s Hansoh Pharma. The deal: $112 million upfront, with potential milestone payments of up to $1.9 billion. A year earlier, AstraZeneca made a similar move, paying $185 million upfront with future milestones totaling nearly $1.83 billion in a deal with China’s Eccogene. (…)

“It’s unquestionable that this has been a big negative for the U.S. biotech ecosystem,” said Tim Opler, a managing director of investment banking at Stifel. “The real question now is how to adapt. How do you maintain leadership in innovation while improving cost efficiency and speed?”

From a patient’s perspective, the growing global competition is a win. People with cancer probably don’t care which country a drug was developed in. What matters is that it works. But for policymakers focused on maintaining America’s competitive edge, China’s biotech surge is a wake-up call. The innovation race isn’t limited to AI or crypto—it extends deep into life sciences. (…)

FYI:

Data: Yahoo Finance. Chart: Axios Visuals

U.S. Services PMIs

S&P Global: Stronger job creation despite slowdown in output growth at start of 2025

The seasonally adjusted S&P Global US Services PMI^® Business Activity Index posted 52.9 in January, down markedly from 56.8 in December but still signaling a solid monthly expansion in business activity in the service sector. Output has now increased on a monthly basis throughout the past two years, with the latest rise generally reflecting sustained new order growth.

The pace of output expansion slowed sharply, however, and was the weakest since April 2024. Some panellists reported that the unusually freezing weather conditions seen in parts of the country had been behind the slowdown in growth.

The securing of new customers and client approval of projects contributed to a ninth consecutive monthly rise in new business. Here too, the pace of expansion eased from December, but remained solid.

The rise in total new business was recorded in spite of a renewed decrease in new export orders, which fell for the first time in seven months. The pace of decline was only marginal, however.

As well as seeing growth of activity ease in January, there was also a slight reduction in business confidence at the start of the year, after optimism hit an 18-month high in December. That said, sentiment remained broadly in line with the series average. More than 42% of respondents predict an increase in activity over the coming year, while only 6% forecast a reduction.

In some cases, confidence was linked to the incoming administration, with economic conditions expected to improve. Marketing activity and increases in new orders were also central to business optimism.

Service providers looked to expand capacity at the start of 2025 and ramped up hiring accordingly. Employment rose for the second month running, with the rate of job creation accelerating to the fastest since June 2022.

Despite stronger jobs growth, the recent period of rising new orders meant that capacity pressures remained evident in January. Outstanding business increased for the third consecutive month. The latest rise was slight, but more pronounced than seen in December.

Higher labor costs was the main factor behind a further sharp increase in input prices in January. The rate of inflation reached a three-month high and was broadly in line with the series average. Higher prices for materials and utilities were also recorded.

In line with the picture for input costs, the pace of output price inflation also quickened in January as companies passed through higher cost burdens to customers. The solid increase in charges was the fastest since last September.

ISM:

The Institute for Supply Management’s gauge of services slipped to 52.8 in January from 54 at the end of the 2024, according to data released Wednesday.

A gauge of new orders placed with service providers declined to the lowest level since June, marking the third month in the last four of cooler demand growth. (…)

The PMIs suggest employment remains healthy but also that inflation is not totally under control just yet. John Authers says that “services prices remain within historical bounds” but only if your history begins in 2013.

ECB’s Wage Tracker Points to Steep Slowdown This Year Pay to rise 1.5% y/y in 4Q 2025, down from 5.3% in 4Q 2024

The ECB’s wage tracker, published Wednesday, predicts salaries rising by an annual 1.5% in the fourth quarter of 2025. While that’s up a touch from the 1.4% projection seen in December, it’s way down from the 5.3% peak recorded a year earlier. (…)

The ECB’s December outlook foresees a sustained decline in salary growth — to 2.8% in 2027 from 4.6% last year. (…)

The Eurozone January PMI surveys:

Turning to prices, January survey data signalled an intensification of cost pressures across the eurozone. The rate of input price inflation accelerated to a 21-month high and was above the long-run series trend. Both monitored sectors recorded stronger rises in their operating expenses at the beginning of the year. Subsequently, euro area firms raised their prices charged more aggressively. Output prices rose at the quickest pace in five months.

EARNINGS WATCH

Via John Authers:

Deutsche Bank AG’s Binky Chadha estimates that 80% of S&P 500 companies topped their earnings estimates, more than the 74% historical average. The size of the aggregate beat, 5.9%, and the beat by the median company, 4.1%, are also above historical averages. Strong performance is broad-based, with financials and consumer cyclicals recording double-digit beats. Sectors like materials, industrial cyclicals, energy, mega-cap growth, and tech are ahead of estimates by mid-single-digit rates. Defensive stocks are more modest:

Importantly, with the exception of energy, all sectors are recording earnings growth, and banks are on course to outstrip third-quarter growth:

The discussions on earnings calls, and what they reveal about executives’ thinking, perhaps matter more — particularly amid the upheavals of Trump 2.0. A search of earnings transcripts reveals that tariffs shenanigans are getting a lot of attention as companies weigh the consequences and seek workarounds. Tariffs hadn’t been as topical since 2018, when Trump 1.0 made punitive levies against China. Meanwhile, at a much lower level, immigration — and its possible ramifications on inflation and the difficulties it could create for recruiting workers — is also attracting far more comment.

(…) executives’ mentions of inflation have dropped back below levels seen before the pandemic, suggesting that they tend to believe the problem is over:

Meanwhile in China:

China: Yet to Bottom

The Chinese corporate profit cycle is worsening, which together with risk aversion in the household sector, signal the economy is yet to bottom.

In business cycle analysis framework the profit cycle is the single most important business cycle indicator. Profits are the core driver of economic activity. It underpins investment decisions, drives innovation and the fluctuations in economic activity. The profit cycle is the leading indicator of the business cycle and marks the tipping points. Moreover in a downturn the stabilisation of the profit cycle precedes the bottoming of the economy. The Chinese corporate profit cycle downswing deepened through the first three quarters of 2024.

In the first 11 months of the year the number of loss-making manufacturing companies rose 11% compared with the same period in 2023, and accounted for over 25% of the manufacturing sector, up from 24% in 2023. Loss making firms are rising across most sectors. The private sector has been hard hit. The number of loss-making industrial companies have been increasing in the private sector since June, up 12.9% YoY compared with 8.7% YoY for state owned, that have been under pressure since August.

The upshot is manufacturing sector profits in the current year to November 2024 were down almost 5% and fell in half of the 34 industrial sectors covered. (…)

Operating costs though are rising more quickly than operating revenues, which together with weak consumer pricing power, is squeezing profit margins and accounts for the weakness of profits. Manufacturer’s operating costs rose by 3.2% YoY between January and November last year. (…)

The corporate debt overhang is growing rather than being addressed through restructuring, consolidation and by weeding out weak companies. By 3Q24 end, corporate debt had surged to 174% of GDP (Figure 7). Combined with persistent overcapacity, this creates a significant drag on economic growth.

Figure 7: Debt as a share of GDP trends

Source: Haver Analytics & Westbourne Research

Private credit growth is slowing even as interest rates fall (Figure 8). The deceleration in corporate credit growth is a positive and reflects healthy caution on the part of banks. The weakness of household credit growth stems from a lack of demand. This trend in private credit growth serves as yet another sign that the economy is not undergoing a sustainable recovery. It also highlights a deeper and more challenging issue—risk aversion.

Figure 8: Domestic credit growth

Source: Haver Analytics & Westbourne Research

Risk appetite is pro-cyclical. However, in China’s case risk aversion has become entrenched and explains why counter cyclical monetary and fiscal policy easing are not working. Risk aversion in the household sector stems directly from the housing market downturn. (…)

Figure 9 shows existing and new home prices, measured on a year-on-year basis, are falling more slowly. However, while the pace of contraction may be slowing, the reality is that both existing and new home prices continue to decline in absolute terms, meaning property values are depreciating year after year.

Figure 9: Existing and new home prices

Source: Haver Analytics & Westbourne Research

The housing market downturn is the root cause of risk aversion in the household sector — and understandably so. For most homeowners, property represents the largest asset on their balance sheet. With a homeownership rate of 90% (compared to 65% in the U.S.) and a significant portion of Chinese households owning multiple properties — over 20% in urban areas and 16% in rural regions — the challenges posed by the property downturn are amplified and is a huge dampener for consumption spending. (…)

Until property prices rise consistently, the lack of risk appetite will continue to suppress household spending and broader economic activity. It is not enough for property prices to stop falling to restore confidence. (…)

SENTIMENT WATCH

Unstoppable Retail Crowd Breaks Stock Buying Record Despite Rout Mom-and-pop investor sentiment has reached record level

Mom-and-pop investor sentiment has reached the highest level on record, surpassing what was seen during the meme-stock mania in 2021, according to Emma Wu, JPMorgan’s global quantitative and derivatives strategist. Individual investor exposure to stocks is near the highest level its been since 1997, an analysis by Barclays’ global head of equities tactical strategies Alexander Altmann shows. And as long as the US economy remains resilient, those investors probably will stay stay in the game.

Even as US stocks got hit Monday when President Donald Trump’s tariff negotiations rattled global markets, mom-and-pop investors continued to buy in. They poured $3 billion into stocks that day and then broke the $2 billion threshold within the first 1.5 hours of trading on Tuesday — the largest inflow at that time of the trading session back to 2015, a JPMorgan analysis shows.

Not surprisingly, about 70% inflows went to Magnificent 7 stocks on Tuesday, the largest on record, JPMorgan’s data shows. And Nvidia Corp., which lost 3% the day before, was a top pick. The daily inflow from retail investors exceeded $2 billion twice last week, a level reached only nine times in the past three years, the bank said. (…)

Trading platform eToro says that on Jan. 27 it saw the largest amount of equity buy orders from retail clients in the last six months. (…)

In a December eToro survey, 59% of respondents said they’re bullish on AI stocks but just 22% had exposure to this group and that majority of them were looking for an opportunity to buy AI names sometime in 2025. (…)

Bessent Says Trump Wants Lower 10-Year Yields, Not Fed Cuts

Treasury Secretary Scott Bessent said the Trump administration’s focus with regard to bringing down borrowing costs is 10-year Treasury yields, rather than the Federal Reserve’s benchmark short-term interest rate.

“He and I are focused on the 10-year Treasury,” Bessent said in an interview with Fox Business Wednesday when asked about whether President Donald Trump wants lower interest rates. “He is not calling for the Fed to lower rates.”

Does this explain that?

The bond market relaxed today after Treasury Secretary Scott Bessent’s debut Quarterly Refunding Announcement (QRA) proved to be a non-event.

Bessent had been critical of Janet Yellen’s usage of short-term Treasury bills to finance the federal budget deficit. Many investors, therefore, were worried that he would issue more longer-term notes and bonds, which would boost bond yields. The QRA said that auction sizes for notes and bonds would remain the same for the coming quarters, which means that bills will remain at a historically high percentage of the Treasury market for the foreseeable future. This also is a positive for the stock market. (…)

An increase in auction sizes would likely upset both the bond and stock markets, and probably President Trump as well. (Ed Yardeni)