Has US wage inflation peaked?

Tom Traill - 13 June 2019

It is tempting to regard the monthly payroll report as a real-time commentary on the US expansion, but this temptation should be resisted. Monthly payroll changes are erratic and ambiguous in their interpretation, especially when the unemployment rate is down at 3.6 per cent. Arguably, annual wage growth offers a cleaner perspective on the relative strength of the labour market and the recent softening of headline rates may be calling the turn in the US economic cycle.

The net 75k addition to non-farm payrolls for May was so far below consensus expectations of 175k, to flummox every Wall Street forecast. Not only was the May figure unexpectedly low, but the March and April readings were revised down by a combined 75k jobs. Although the (U-3) unemployment rate remained at 3.6%, average hourly wage growth in the whole economy slipped back to 3.1%, and weekly wage growth for productions workers, to 2.7%. If the unemployment rate is below most estimates of the natural, or frictional rate, then wages should continue to accelerate.

Figure 1, a version of a chart created initially by Brian Pellegrini of Intertemporal Economics, indicates a close inverse relationship between annual wage inflation and the unemployment rate, with wages tending to take off around when unemployment falls below the (neutral) 5.5 per cent rate and peaking around the point when unemployment troughs. This time around wage inflation had a false start but has since risen to 3.5%. If unemployment has reached its lows, then logically, wage inflation has peaked.

Figure 1

Data source: St Louis Federal Reserve and Intertemporal Economics

The soft payroll report, of itself, carries little weight in the overall assessment. The series is noisy – there was a 56k in February and an 18k in September 2017 – and prone to disruption from weather events and government shutdowns. The diminished pace of job additions – 164k per month in 2019 as against 223k new jobs per month in 2018 may simply reflect a shrinking pool of available labour and the greater difficulty in filling positions. However, this seems incompatible with the weakening wage growth seen in both the average hourly earnings series annual growth and in the wages and salary component of the employment cost index.  

While the May data point for payrolls is subject to two rounds of revisions in coming releases and future data points may compensate with stronger growth, the greater likelihood is that employers are becoming less confident about future business prospects, in response to negative messages regarding tariffs and prospective supply chain disruptions and are reining back their hiring and limiting wage offers to job-switchers. The Atlanta Fed wage tracker reports a dip from 4.6 per cent to 3.9 per cent for job-switchers and from 3.9 per cent to 3.3 per cent for job stayers. This is all taking place against a background of growing concerns that the US economy is running out of steam.  

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