By: Ken Green & Phil Kernen
In early 2021, as inflation first breached 2%, the Fed displayed little concern, believing reopened supply chains would correct any imbalances. It didn’t. Instead, price increases have burrowed their way through the economy, first impacting goods prices and now spreading into the cost of services. What does this mean for the future path of inflation and the resulting direction of Fed policy?
The most recent inflation reports show goods price increases slowing while service price increases pick up, underscoring a big problem. Services constitute two-thirds of our economy, and a material portion of service prices comes from labor costs. Wage growth will have a significant impact on inflation.
Energy and food inflation is the typical starting points for inflation. But they bounce around a lot and are less sticky, explaining why the Fed downplays their effects and removes them to focus on core inflation. On the other hand, labor costs are much stickier, more broadly impactful, and present a more intractable problem for monetary policymakers.
The Fed’s biggest fear is a wage-price spiral. Consumer prices rise, and wages follow because employees demand raises to keep up. Employers respond by raising prices more to match their higher costs. Wages and prices become trapped in a circular dance, with each leading the other to the next step. The Fed insists we aren’t there yet, but its conviction is weakening. The rising cost of living is in play, and examples of the growing leverage of labor and rising associated costs are everywhere.
Strikes in the UK, Germany, and South Korea initiated disruptions across multiple industries, all based on seeking higher pay to address the cost of living pressures. Congress turned to a law crafted before the Great Depression to stop U.S. rail workers from striking and incurring $2 billion in daily damages to the economy. Even the U.S. government expects to raise wages by 4.6% in 2023. What can we draw from current labor market data to deduce the direction and degree of labor inflation in 2023, and what will the Fed do in response?
Average hourly earnings
The Bureau of Labor Statistics (BLS) reports employees’ average hourly earnings each month, which grew 5.1% in November from the prior year. Wage growth this fast may appear manageable in the context of 6-7%+ inflation, but consider that the data series shows annual wage growth exceeding 5.0% during all but two of the last twelve months.
A separate wage growth tracker from the Federal Reserve Bank of Atlanta reflects higher levels. In November, annual wage growth clocked in at 6.4%, somewhat below the peak of 6.7% last summer but unchanged from October. Those who switched jobs averaged 8.1% wage growth, while raises given to those who stayed averaged only 5.5%. Taken together, accelerating wage growth is a problem for the Fed.
The unemployment rate has dropped steadily from 14.7% in April 2020, reaching 3.5% in December 2022. Employers created more than 4.5 million jobs over the last twelve months. While this represents a slowdown from the 6.7 million created in 2021, the current rate far exceeds any levels consistent with driving consumer demand lower.
Each month the BLS produces the Job Openings and Labor Turnover (JOLTs) report, which reports data on the degree and methods of how workers change jobs and where shortfalls exist. At the end of November 2022, public and private employers reported 10.5 million open positions compared to 11.1 million last year. This is progress, but employers are still adding payroll and associated support to address expected demand. Statistically speaking, every one of the 5.5m people looking for a job has 1.9 open positions to consider, unchanged from the 1.9 open positions twelve months ago.
Soft data reflects the same. November’s consumer confidence survey from The Conference Board showed that 48% of consumers think jobs are plentiful and 13% think jobs are hard to get. In a survey earlier in 2022, the most cited reason for quitting and changing roles is wage stagnation against rising living costs. With workers in such short supply they can demand higher wages, especially those changing jobs
While job openings overall are slowly declining, those industries experiencing growth in open jobs are primarily service-based that rely on a robust labor pool. Complicating matters is the slower growth of the labor force over the last few years. According to the Fed, the labor pool is short about 3.5 million workers compared to what pre-2020 trends might have suggested. Blame sluggish population growth over the last few years, with COVID accelerating declining birthrate and rising death rate trends, immigration policy logjams, and two million early retirements.
Initial jobless claims
Produced weekly by the Department of Labor (DOL), initial jobless claims track those newly unemployed filing for benefits for the first time. The most recent figure showed 204,000, lower than last month, about the same as last quarter, but higher than earlier this year. In other words, jobless claims are slowly and inconsistently moving higher. A partial explanation may come from employers who are hesitant to shed employees given the expense of finding and training new team members compared to keeping them on the payroll in the face of continuing demand.
Continuing claims track those past their first week who remain unemployed. The last weekly figure showed 1.69 million, higher than the previous month and quarter but lower than last year. The duration of unemployment is also declining, with employees out of work for fewer than 26 weeks growing as a percentage of the labor force and those unemployed more than 26 weeks nearly cut in half, becoming a smaller portion of the unemployed. Separated employees find new employment faster than before because many open positions still need to be filled.
All this data suggests inflation pressures remain daunting and not easily suppressed. Despite 4.25% in interest rate increases in 2022, the Fed has yet to begin to dent demand. It has been vocal about controlling inflation and overpowering the desire to pull back prematurely. The continuing strength of the labor market shows it still has more work to do.