After years of strong employment growth, it looks like wage pressures in the United States are now starting to build.
In January, average hourly earnings grew by 0.3%, leaving the increase on a year earlier at 2.9%, the fastest pace since the global financial crisis.
Given the implications for domestic inflationary pressures, markets are now concerned about what that may mean for the outlook for monetary policy settings from the US Federal Reserve.
Specifically, many think an acceleration in wage growth — not only in the payrolls report but in other recent indicators on labour costs — could mean that the Fed will hike rates more aggressively than markets currently expect.
From two to maybe three, it’s now increasingly common to see forecasts for three rate hikes or maybe even four.
The bond market has certainly taken notice with yields on benchmark 10-year treasury notes ending last week at 2.84%, a fresh multi-year high. Other markets, after viewing rising US bond yields favourably in January, are now also taking notice, seeing stocks and commodities fall heavily in recent trade as concerns increased as to what higher yields could mean for economic and earnings growth.
To Elliot Clarke, Economist at Westpac, there is “growing evidence that reduced slack in the labour market is supporting stronger wage outcomes”, pointing to the chart below showing the ongoing decline in US unemployment and underemployment levels.
“The more slack is reduced, the greater the likelihood that this uptrend will accelerate,” he says.
However, while markets are now clearly concerned that faster wage growth could lead to a faster inflation and a faster hiking Fed, Elliot is not convinced that it will lead to more rate increases in the US this year.
“The impact on inflation [of higher wage growth] though is not necessarily one for one,” he says, adding that “that demand-led inflation has limited support”.
This next chart helps explain why.
It shows the US savings ratio — the proportion of income saved by households — overlaid against real personal income growth on a per capita basis.
While wage pressures are building, the savings ratio continues to decline while real income growth remains weak, creating two potential headwinds for any potential pickup in demand-led inflationary pressures.
“Households have continued to dis-save in recent years such that their savings rate is near record lows,” says Clarke.
“Further, in a rising rate environment, consumers are likely to become far more mindful of the rising interest cost and risks they are taking on by using credit.”
Given the limited ability for households to lift consumption levels in such an environment, Clarke says that carries the potential to cap any potential lift in inflation pressures.
“For inflation and policy then, the improved wage growth trend is more likely to see inflation consistently around target than materially above it as the economic growth cycle is sustained,” he says, referring to the Fed’s 2% annual target for core personal consumption expenditure (PCE) inflation.
“A need to raise the fed funds rate more than three times this year is therefore unlikely.”
This provides a gentle reminder that while wage pressures are an important part in the inflation jigsaw puzzle, it’s not the only factor that should be considered.