Forex Flash: Productivity slowdowns portend bearishness in equities and rates – Goldman Sachs

Two of the ‘jointly bearish’ scenarios that we considered in our previous analysis were effectively driven by ‘productivity risk’. That is, the risk that productivity growth would slow and drag down the trajectory of long-run growth. The three scenarios that we identified were that inflation expectations ‘drag anchor’ as productivity growth slows; foreign investors turn negative on US sovereign risk; and retail sentiment abandons fixed income.

“Of these, we argue that the first two are heavily exposed to productivity risk. Our leading scenario conjectured that inflation expectations could ‘drag anchor’ owing to an unexpected rise in core inflation pressures resulting from slower-than-expected productivity growth. When an economy is operating well below full capacity, it is difficult to construct a scenario with rising inflation without assuming that investors have begun to lose confidence that inflation is in fact well anchored. The most natural way to construct a scenario of rising inflation expectations is to assume a productivity shock of some sort, most likely a negative oil supply shock.” writes the Economics Research Team at Goldman Sachs.

An alternative version might be a broader productivity slowdown arising, say, from underinvestment in the wake of the global financial crisis. Given the poor quality of productivity data in real time, news of a broad slowdown in productivity growth would arrive gradually and across a variety of indicators.