Wage Gains Move Front and Center for the Fed

As you read this, the January employment numbers will have been released and will probably signal a third straight month of sub-250 thousand job gains.  Will that slow the Fed in its newly redirected path to stamp out inflation? No. First, the weakness can easily be explained away as another Omicron influence. Second, the more important metric to the Fed right now in the report is probably average hourly wage gains.

While the Fed has put away its use of the word transitory, they still, in their heart-of-hearts, believe that most of the inflation to date has been driven by supply-chain snafus. That has led to an imbalance in surging demand versus suppliers caught offside, especially with the Delta and Omicron variants continuing to hamstring restocking efforts. We explore in more detail below the wage issue, and why the Fed will likely be attuned to those numbers, and how that will influence policy as we move through the first half of 2022.

In this week’s podcast, yours truly and Chad McKeithen take a crack at what we learned from the FOMC meeting and what it might mean for rates this year. We wrap that all up in an investment outlook for 2022. It’s just over 30 minutes so do give it a listen on your way to or from work. The iTunes link can be found here and the Spotify here.


Rate Hikes – Early and Often?

As we mentioned above, the Fed will most likely be fixated on the wage figures coming from the January jobs report. While supply-side shortages can create price pressures, they tend to be temporary as supply/demand imbalances are eventually resolved. The issue the Fed is more concerned about is whether wage gains accelerate to a pace that generates another, and longer-lasting, avenue for price increases. Last week’s Employment Cost Index (probably the most robust wage/income data series), posted a quarterly gain of 1.0%. That was after a 1.3% gain in the third quarter.  The graph below tracks the ECI series in a year-over-year basis including the latest fourth quarter data.

Source: Bloomberg

As the graph shows, with the fourth quarter data, the year-over-year rate has jumped to 4.0%, the highest since a 4.2% rate in December 2001. As you can also see, the period after the Great Recession was characterized by year-over-year wage gains mostly below 2.50%, except for the last couple years of the decade. Even then they couldn’t surpass 3.0%. Recall too that period was characterized by inflation well below the Fed’s 2.0% target rate despite long periods where the fed funds rate was at the zero lower-bound.

With current wage gains now at 4.0% YoY, the Fed will be laser-focused on how wages behave as they begin to hike rates in March. If the gains continue to move over 4.0%, expect them to continue hiking early and often. Does that mean they go 50bps in March? It’s probably too early to make that judgment. 25bps is still the consensus call. The January CPI report next week, and the February CPI report on March 10, will no doubt be a huge influence on the rate call at the March 16 meeting. But the wage numbers in the employment reports between now and the March meeting, if they continue to ramp higher, could sway some members to vote for a 50bps hike, just like four of nine Bank of England governors voted for yesterday.

Average Hourly Earnings Also Signaling Accelerating Wage Gains

The wage series from the monthly jobs report is shown below, in year-over-year format. As you can see, the wage increases picked up in the ECI numbers are also reflected in the employment report’s wage series. The latest month had wages accelerating 4.7% year-over-year. The expectation for the January report is for that to accelerate even further to 5.2% year-over-year.

Source: Bloomberg

As the graph also shows, the current wage gains are levels not really seen dating back to the advent of the series, except for the spikes around the re-opening period. Also, just like in the ECI series you can see the wage gains coming out of the Great Recession were very muted. Mostly in the 2.0% range. This helped to keep inflation during that period under 2.0% as well. The Fed will be watching these numbers closely, and if the current gains remain, and/or increase, you can expect they will keep their hands on the hiking button as we move through the year

Agency Indications — FNMA / FHLMC Callable Rates

Maturity (yrs) 2 Year 3 Year 4 Year 5 Year 10 Year 15 Year
0.25 1.23 1.50 1.70 1.95 2.36 2.82
0.50 1.21 1.47 1.64 1.84 2.22 2.71
1.00 1.21 1.44 1.61 1.80 2.13 2.58
2.00 1.43 1.55 1.72 2.01 NA
3.00 1.67 1.94 NA
4.00 1.90 NA
5.00 1.86 NA
10.00 NA

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Published: 02/03/22 Author: Thomas R. Fitzgerald