There will be pain
Unfortunately for workers, wage inflation at heart of Fed tightening.
[Editor’s note: My writer and I failed to coordinate vacation schedules, so this week, I’m taking a look at the tight labor market and inflation. My regular column will return next week.]
All countries are confronting commodity- and supply chain-induced inflation. Only the U.S. is facing significant wage pressures, too. Never has the domestic labor market been so tight. Not even close. Even with a jobless rate hovering near a 50-year low, job openings are running at nearly double their early 2020 pre-pandemic pace. In April, there were 11.4 million openings vs. 5.9 million unemployed, almost a 2-to-1 ratio. And the jobs-workers gap currently stands at 4.6 million workers—or 2.8% of the labor force, the most overheated level in postwar U.S. history. The absence of any slack makes an already difficult task almost impossible for the Fed. It will attempt to tighten enough to discourage job openings and calm wage pressures, without causing recession. The odds of success arguably aren’t good.
With companies desperate to find help, a potential wage-price spiral has always loomed in this cycle. But it was the supply-demand mismatch in goods that initially stirred the post-Covid run-up in prices. Stuck at home early in the pandemic, either still being paid or getting unprecedented stimulus checks, Americans and much of the world bought TVs, computers, bikes, furniture, home and patio additions/upgrades. (Except for bikes, I’m guilty!) And all kinds of other stuff. (Me too!) The surge in demand coincided with global Covid lockdowns that sporadically shut down production and made it difficult to ship all the goods. These bottlenecks have started to reverse. With the pandemic easing, more facilities are operating and shipments are rising, just as demand is starting to fade amid the double whammy of rising rates and inflation. But supply disruptions remain a factor, especially in energy and foodstuffs where the Russia-Ukraine war is creating havoc.
The bigger problem is services inflation. It tends to be “stickier” and accounts for roughly 60% of CPI, and is surging. While goods inflation is set by global factors, services inflation is set in large part by domestic forces, led by wages. Hence the focus on slowing an overheated jobs market. To be sure, services costs are being hit in other ways, too. Gas prices are closing in on all time inflation-adjusted highs, caused not just by supply shortages but a summer in full swing as Americans hit the roads and skies, go to theme parks and the beach, sleep in hotels and motels, and eat and drink at bars and restaurants. Food costs are soaring, too, for restaurants and for their customers regardless of where they dine.
But stripped to the core (which does away with volatile food and energy), it’s all about wages. With the job-workers gap near its highest level in postwar history, wage growth climbed at a 3-month average 6.1% in May, according to the Atlanta Fed’s wage tracker, with a big chunk coming in services jobs. Workers with a college degree saw their wages climb a more moderate, but still elevated, 5.4%. Part of the increase comes as companies are trying to woo and keep employees who are dealing with inflation. May year-over-year (y/y) headline CPI climbed 8.6%, the most in 40.5 years.
So, higher inflation is helping beget higher wages, even without widespread cost-of-living adjustments that were so rampant in the stagflationary 1970s. Despite the best pay raises in generations, the decline in real wages explains why so many consumers are so gloomy (Michigan’s initial read of June sentiment plunged to its lowest in the series 44-year history). As much as their paychecks are growing, workers’ costs are rising even faster. To fix the conundrum, the Fed may have to make the situation worse. With the jobs market a source of persistent inflation, it needs to slow the economy enough to crush demand, discourage job growth and push up unemployment. How bad might it get? Too soon to say. But there will be pain.
Perhaps the pain will be “transitory”
- Look to the shadows One potential factor that could help loosen the labor market and wage pressures is the so-called “shadow labor force,” i.e., people who want a job but haven’t been looking. It’s estimated this shadow force is running about 740K above its pre-pandemic level, which if it starts to normalize could help bring labor demand and supply into balance by year-end, moderating wage inflation.
- Peak tightness The Royal Bank of Canada notes the last two Conference Board consumer confidence surveys showed jobs plentiful to jobs hard-to-get declining sequentially, lowering the 2-month average to levels consistent with labor market deterioration. That this happened before the Fed’s rate hikes kick in (they work with long lags) makes this significantly meaningful, RBC says.
- Peak tightness While historically very elevated, job openings have moved sideways since mid-2021, and there are signs in business surveys and alternative data that they may be starting to down. Additionally, labor force participation has started to turn up as Covid fears recede, excess savings are exhausted and higher inflation means dollars don’t stretch as far.
- Peak wage inflation? After surging in 2021, the y/y pace of wage inflation has essentially been flat for eight months and in May, eased to 5.2%.