Inflation is accelerating toward the U.S. Federal Reserve’s target, which should lead to a long-awaited pickup in wages. But if wage growth remains sluggish, even a modest overshoot of inflation could weigh on consumer spending.
The April jobs report revealed that wage growth remains tepid, rising just 2.6 percent from a year earlier. This occurred even as unemployment sunk to 3.9 percent, a level the Fed believes is consistent with an economy operating beyond full employment. Theoretically, such tight labor markets should foster higher wages as firms compete for workers. Yet, so-called real wage growth, which is what workers get after taking into account the Fed’s preferred measure of inflation, decelerated to an estimated 0.6 percent rate in April.
Using headline measures of the consumer price index, the news is even more disappointing, with average real wages up just 0.2 percent from a year ago. Real wage growth in this range would be well below productivity gains, which have averaged 1.3 percent the past four quarters, and inconsistent with the lowest unemployment rate since 2000. Nevertheless, I expect wages to rise in line with inflation, keeping growth in real wages in a 1 percent to 1.5 percent range. That’s anemic, but consistent with conditions just prior to the last recession.
The news on wages isn’t all bad. The rate at which workers are leaving their jobs has accelerated to cycle highs in the past six months as measured by the Jobs Openings and Labor Turnover report. This indicates a strong labor market where workers are confident that if they leave their job they can easily find another. Based on its current trajectory, the quit rate may soon reach levels not seen since the series began back in the hot job market of 2000.
One factor prompting workers to quit jobs is the prospect for higher wages. The Federal Reserve Bank of Atlanta’s wage measure for job switchers – people who leave one employer for another – has rebounded to cycle highs in recent months, reaching 4.4 percent in March and 4.0 percent rate in April. Seems like a good environment for workers facing stagnating real wage growth to start looking for greener pastures, forcing firms to boost compensation more aggressively to attract and retain employees. Although this would be good for consumer spending, corporate profit margins might get pinched unless employers can cut costs elsewhere.
If the current expansion has taught us anything it’s that we should temper our expectations. Wage growth might fail to materialize, in which case the Fed would find itself struggling to justify further interest-rate hikes. Recall former Fed Chair Janet Yellen’s warning from 2014:
“My own expectation is that, as the labor market begins to tighten, we will see wage growth pick up some, to the point where real wage growth, where compensation or nominal wages are rising more rapidly than inflation… If we were to fail to see that, frankly, I would worry about downside risk to consumer spending.”
Something similar holds true today. If wage growth remains slow while inflation accelerates, consumer spending would suffer. Central bankers would likely reconsider their rate hike plans under such circumstances.
For now, weaker consumer spending in the face of higher inflation is just a risk. The New York Federal Reserve’s Survey of Consumer Expectations reveals that spending expectations over the next year remain steady while the University of Michigan’s consumer sentiment measure hovers near cycle highs. Neither suggests spending concerns on the part of households. Moreover, retail sales posted healthy gains in April, while March was revised upward. Overall, it looks like underlying consumer spending remains solid.
It is unlikely that companies can hold the line on wages – and depress real wage growth – when low unemployment encourages workers to quit their jobs in search of a higher salary. The Fed expects this as well, which is why faster wage growth alone will not prompt an acceleration in the pace of rate hikes. The surprise would be if wage growth didn’t accelerate. Such an outcome would call into question both the durability of consumer spending and the viability of the Fed’s expected rate path.
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