Wage growth is accelerating, and that could change the Fed's plans

The jobs report was pretty strong in the past two months.

The US economy added 547,000 jobs in June and July, according to the Labour Department. Meanwhile, average hourly earnings jumped 2.6% year-on-year, the highest rate since the Great Recession.

And so this means that wage growth could be speeding up. Current trends suggest wage growth could reach 3% by the first quarter next year, according to Jason Thomas, managing director and director of research at private equity giant Carlyle Group. Thomas shared a chart showing a statistical model of the average hourly earnings growth rate:

“Wage growth of about 3% annually would be consistent with a moderate tightening cycle, while further acceleration to 3.5% or 4% may prompt faster tightening than is currently contemplated,” Thomas told Business Insider. Jobs growth in sectors like healthcare and hospitality were especially strong.

Of course, it’s worth noting that predicting the future is extremely hard. Just because wage growth has followed a particular rough trend over the last few years doesn’t necessarily mean that it will continue on that trend in the coming months and years.

Inflation has yet to break out, and broader weakness in the US economy — which has expanded at an annual rate of just 1.2% so far in 2016 — has bolstered those who don’t expect the Fed to tighten monetary policy any time soon.

While Thomas thinks the odds of a September hike remain low, a rate hike in December and one or two more in 2017 is supported if the pick up in wage growth continues. Those expectations are in sync with a recent poll by Reuters.

Former Fed chair Ben Bernanke noted recently that policymakers have significantly revised their estimates of America’s economic health, including potential US economic growth, the long-run unemployment rate, and the value of the federal funds rate in the next few years. Those revisions suggest the Fed expects to remain cautious in the wake of what they see as a not-fully-recovered economy.

Here is Thomas again (emphasis ours):

“Policymakers seem to believe that a fed funds rate of 0.4% is a much less accommodative stance for monetary policy than historic data would suggest. Instead of expecting to raise rates to a target of 4.25%, the median policymaker now expects to raise rates to just 3%, with some suggesting the fed funds rate may not reach 2%. Longer-term yields have adjusted downward as a result and broader financial conditions have eased significantly since February. IF labour market data signal more near-term inflationary pressure than is currently anticipated, these plans may have to be altered. The Fed may have to balance its desire to keep rates low with the need to respond to wage and price developments.

It’s important to note, as we observed above, that predictions of wage growth — like any statistical model based on the recent past — are built with an assumption that recent trends will continue. As a further caveat, average earnings may not be the best gauge of wage trends. That’s because amid a shift from high-paying industrial jobs to low-paying service jobs, weakness in sectors like heavy manufacturing and mining may disguise some of the wage pressure in other industries, Thomas said.

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