'Economy of Dreams' 'Economy of Dreams' http://www.federatedhermes.com/us/static/images/fhi/fed-hermes-logo-amp.png http://www.federatedhermes.com/us/daf\images\insights\article\field-lights-small.jpg February 23 2024 February 23 2024

'Economy of Dreams'

Strong wage growth keeps Fed cuts off the bases.

Published February 23 2024
My Content

Bottom Line

In the classic 1989 baseball film, “Field of Dreams,” a farmer played by Kevin Costner hears a voice whispering cryptically, “If you build it, he will come.” Referring to Shoeless Joe Jackson, that famous line spawned hundreds of parodies. One came to me as I read the FOMC minutes released Wednesday that referenced the surprisingly robust U.S. economy and labor market. Surely Fed Chair Powell must be haunted by some ghostly economist whispering, “If they earn it, they will spend.”

Indeed, many prominent economists have been forecasting a recession that unlike the ghost of the defamed Shoeless Joe, simply hasn’t materialized. That’s in large part because the job market remains strong and consumer spending on both goods and services robust. That creates a dilemma for the Fed, which is perhaps just as determined to bring inflation to its 2% core PCE target as Costner’s character is to build a baseball diamond on his isolated cornfield. In Powell’s mind, the appropriate level of wage growth commensurate with 2% inflation should be 3%. But wage growth has been running well above that level.

K-shaped labor-market recovery is unequal The overall unemployment rate (U-3) remained at 3.7% in January 2024, hardly higher than April’s 53-year low of 3.4%. But for the fourth consecutive month, the rate for highly educated workers was 2.1%, marginally above September 2022’s cycle low of 1.8%, while the rate for less-educated workers, at 6.0% in January, is well above its 31-year low of 4.4% in November 2022. The demand for skilled labor is running hotter, helping to keep wages elevated, as these positions typically pay more.

Wage inflation soars while hours worked plunge Average hourly earnings rose to a nearly 2-year high in January 2024 by a faster-than-expected 0.6% month-over-month (m/m) gain (consensus at 0.3%), which annualizes to a sizzling 7.2% pace. On a year-over-year (y/y) basis, wages increased to a faster gain of 4.5% (consensus at 4.1%), well above the 60-year average of 3.1% and the Fed’s 3% target.

To operate with these elevated labor costs, many companies are reducing average weekly hours worked. They plummeted to a 4-year low of 34.1 in January 2024, down from 34.3 in December and well below the record high of 35 in March 2021. Each decline of 0.1 hour worked is the equivalent of cutting an estimated 350,000 jobs from the economy. And it is often a leading indicator, as employers tend to cut hours before they cut staff.

ADP wages also hot Although private payroll gains in January 2024 are near a multi-year low, wages are resilient. Job stayers enjoyed a solid 5.2% y/y wage increase in January, though that was the lowest growth rate in 29 months and is down from a peak of 7.8% in September 2022. For those who changed jobs, wages rose a strong 7.2% in January, but that was a 32-month low and less than half the cycle peak of 16.4% in June 2022.

Similar story for the Atlanta Fed wage tracker Its growth of 5% y/y in January is close to the 5.2% of both November and December, but down from the peak of 6.7% in August 2022. Job stayers enjoyed a solid 4.7% y/y increase in January (versus 4.9% in December and 4.6% in November), down from 5.6% in August 2022. For those who switched jobs, wages rose 5.6% in January, essentially at the 5.7% mark in each of November and December and down from a peak of 8.4% in August 2022.

Employment cost index starting to soften It rose a slower-than-expected 0.9% quarter-on-quarter (q/q) in the fourth quarter of 2023 (consensus at 1.0%), versus a 1.1% increase in September 2023. That’s down from its cycle peak of 1.4% q/q in March 2022, though still above its historical average of a 0.73% q/q gain. On an annualized basis, December 2023 came in at a 4.2% y/y compensation increase, down from its 5.1% cycle high in June 2022 but above the 2.9% longer-term average.

Unions are smacking home runs Union membership of the U.S. labor market has fallen by half over the past 40 years to about 10% today. But there’s no question they scored big in 2023. Many unions negotiated wage gains well above the inflation rate. Some high-profile examples:

  • United Parcel Service 35% wage gains over five years (7% annual average) for its 340,000 workers.
  • West Coast dock workers 32% increase over six years (5.3% average) plus a one-time “hero” bonus for its 22,000 members.
  • United Auto Workers 25% gains over four years (6.3% average) for 150,000.
  • American Federation of State, County and Municipal Employees in Illinois 19.3% wage growth over four years (4.8%  average) for 35,000 members.
  • Airline pilots
    • Delta 34% wage gains over four years (8.5% average) for 13,000 pilots.
    • American 46% increase over four years (11.5% average) for 15,000.
    • United 40% gains over four years (10% average) for 16,000 pilots.
    • Southwest Airlines 50% wage growth over five years (10% average) for 11,000 pilots.

California restaurants could be pricier this spring The minimum wage for fast-food workers in California will surge to $20 an hour in April, a 25% increase from the Golden State’s broader $16-an-hour minimum wage. According to restaurant industry management consulting firm Revenue Management Solutions, these eateries will need to increase prices by 2% for every $1 increase in the minimum wage to maintain profit margins. 

How might companies and the Fed respond? There’s no question that the dearth of skilled workers amid a solid economy has kept upward pressure on wages, so how might companies navigate higher labor costs? If they pass them onto customers in the form of higher prices, inflation likely will remain elevated, which could hinder the Fed’s plans to lower interest rates this year. But if companies are concerned about losing market share, they might absorb the increases, which could result in slimmer profit margins, lower corporate earnings and declining share prices. Companies also could introduce more technology to reduce their reliance on human capital. That strategy could boost productivity, reduce hours worked, prompt layoffs, and lead to store or plant closings. 

The combination of these factors could result in economic stagflation, meaning persistent inflation and slower economic and corporate profit growth. The Fed’s wisest course of action may be to take a wait-and-see approach and let the incremental data direct its next monetary policy decision.

Connect with Phil on LinkedIn

Tags Markets/Economy . Equity . Inflation .

Views are as of the date above and are subject to change based on market conditions and other factors. These views should not be construed as a recommendation for any specific security or sector.

Personal Consumption Expenditures Price Index (PCE): A measure of inflation at the consumer level.

The Employment Cost Index (ECI) is a quarterly measure of compensation costs for U.S. businesses.

Issued and approved by Federated Advisory Services Company