Wage and Price inflation - More Good News

Written by Richard Hokenson 

When the unemployment rate fell below 6% in September 2014, more than a few economists proclaimed that the labor market was at full employment which would result in a sustained acceleration in wage growth. That chorus become even more vocal when the unemployment rate fell to 5.5% in February 2015. More than two years later with the unemployment rate now at 4.4%, even more economists are stating that full employment has been reached. Wages, however, remain deaf to their voices. Either as measured by the monthly data series on average hourly earnings(AHE) or the quarterly Employment Cost Index (ECI), wage inflation remains tepid (see Charts 1 and 2). Actual developments remain consistent with our view that the full-employment unemployment rate is close to 4%.


Besides continued favorable news on wages, the additional positive was an easing in the rate of inflation for the implicit deflator for personal consumption expenditures (PCE), both with and without food and energy, just as it had appeared that the target set by the Fed was in reach (see Chart 3). As previously discussed, a major culprit in core inflation has been rising rates of inflation for shelter (rent and owners’ equivalent rent).


The rate of inflation in the core CPI ex shelter has been decelerating for several months (see Chart 4). Unfortunately, that same data series is not available for the PCE deflator. We expect inflation to continue to surprise on the downside, a view now bolstered by the fact that rental prices have flattened (see Chart 5).


In our opinion, the Fed has correctly interpreted weak first quarter GDP and March payroll data as temporary pauses. The overwhelming consensus appears to be that they will raise rates at the June FOMC meeting. The lack of an acceleration in wages and an easing in price inflation might not be enough for them to delay but it should affect how they view any subsequent hikes.


This update was researched and written by Richard Hokenson, as of May 11 2017