From Elliot Clarke at Westpac:
The continued reduction in labour market slack in recent years has brought with it anticipation of strengthening wages growth. The closer ‘full employment’ has drawn, the stronger that expectation has become in the minds of the FOMC and market participants.
Against this backdrop, the much weaker than expected Q2 employment cost index result was a significant surprise for the market. At just 0.2%, it was the weakest quarterly outcome in the history of the survey, which dates back over 30 years.
The question is what, if anything, does this mean for FOMC policy?
As is often the case, all is not quite as it seems. Anecdotes on wage agreements in Q1 (notably the string of minimum wage rises implemented across the US) likely mean that Q1’s 0.7% outcome was biased to the upside – to the detriment of Q2. The best guide to ‘true’ wages momentum is likely found by averaging growth over the first half of the year. Doing so gives an annualised growth pace of 1.6% for total compensation which, while softer than 2014’s 2.4%yr, is still an ‘ok’ result relative to it’s post-GFC history.
ensation series has lost considerable value as an indicator of income growth for the average household of late owing to abrupt movements in the benefits industry detail. In particular, note that over the year to Q1 2015, annual growth in ‘information’ total compensation jumped from 0.8% to 6.8%; then in Q2, it slumped back to –2.1%.
The timing of the initial jump indicated the surge may have been due to the arrival of ‘affordable health care’; but detail made available with this release points to the sharp movements being due to other supplementary benefits offered to staff, most likely stock and option grants. The accuracy of this finding rests on the BLS’ heavily-caveated aggregate health benefit cost series. It rose at a 2.8%yr pace in Q2, up from 2.5%yr in Q1 2015 and 2.4% in Q1 2014; herein is no evidence of a health-benefit induced shock.
Further, the total compIf we abstract from the benefits series and instead focus on wages only, what we see at the industry level is a clustering of outcomes at, or around, 2.0%yr. Gains in excess of that level have been reigned in of late – notably for professional services and trade, transport & utilities – but most industries are still experiencing stronger wages growth than has been the case post-GFC. The aggregate wages growth rate of the past six months (annualised) and the past year (respectively 1.8% and 2.1%yr) represent steady, broad-based wages growth across the US economy.
Albeit perhaps a tad disappointing, stability in wages growth around 2.0% is not enough to put a halt to initial rate increases. The FOMC believe the windfall associated with the 2014/15 oil price decline is yet to be spent and therefore anticipate a boost to real spending in the near-term. Further out, the Committee arguably see attaining full employment as an (inevitable) boon for wages growth; hence they hold little concern for the longer-term outlook either.
It will not be until 2016 that wages may provide a downside risk to FOMC policy. During this period, there will be two key avenues for a negative surprise: if nominal wage growth fails to accelerate in line with inflation (as the disinflationary impact of oil and the US dollar unwinds), resulting in declining real wages; or, if real wages growth is positive, consumer spending deteriorates, raising questions over the transmission of wage gains to discretionary spending. Only after a material deterioration became evident in the data would the FOMC potentially be willing to curtail the normalisation process while the Fed Funds rate still remained at historically-low levels.
Good stuff but it’s inflation not wages that is the risk to Fed hikes.