PostEverything | Perspective
February 2, 2018 at 12:15 PM
Once again, the monthly jobs report brought mostly good news. Employment growth remains solid, and we even got a nice pop on wage growth, which has been a critically missing piece from this recovery. The top-line wage series in the report — hourly wages of private-sector workers — rose 2.9 percent in the past year, before accounting for inflation. Because inflation has been running about 2 percent, that implies about a 1 percent gain in real, paycheck buying power.
So, all good, right? Not so fast.
Financial markets got spooked by the wage bump. The figure below shows a sharp spike to a four-year high in the yield on the 10-year Treasury bill as soon as the jobs data came out at 8:30 this morning. WTS?!? (Why the spike?!?)
Yield on 10-yr Treasury
Because, to these folks, higher wages now mean higher prices later, and that means bond investors expect borrowers to pay them an inflation premium. The yield spike also reflects the view — again, motivated by the expectation of faster future price growth — that the Federal Reserve will raise its benchmark interest rate more quickly than planned, and that expectation gets quickly built into market yields.
Now, there’s nothing necessarily wrong with higher interest rates. Even with the spike, yields on the 10-year Treasury, which have averaged 3.5 percent since 2000, are still pretty low. But higher rates, especially at the Fed, do act like a tap on the growth brakes; they also raise the cost of servicing our large and growing (thanks, Trump tax cut) government debt.
But I think the market is overreacting. I don’t think these wage gains are inflationary. I think they’re necessary, long overdue and should be welcomed with open arms. Here’s why:
• One month does not a new trend make. The figure below plots this wage series with a six-month moving average. The recent spike leads to a slight nudge up in the smooth trend, but these monthly series are noisy, meaning there’s no evidence yet of a shift in the trajectory of wage growth.
• Other series show other trends. Today’s report also includes wage data for the lower-paid 80 percent of the workforce who have blue-collar or nonmanagerial jobs. It was up 2.4 percent, implying that faster wage growth last year mostly benefited higher-paid workers. That said, you can find wage data that shows more of an acceleration, so, as I emphasized above, at this point, it’s hard to nail down the underlying trend.
• People who depend on their paychecks rather than their stock portfolios, which is, of course, most working-age people, need a chance to make up lost ground. One place to see this is in the national share of income going to compensation, which took a big hit in the last recession and has yet to recover. For the line in that graph to make back its losses, more of the nation’s GDP growth would have to go to paychecks rather than profits, which is a) noninflationary, and b) a very good thing!
• The assumption that wage growth will automatically bleed into price growth is not so tenable these days. While that correlation is evident in the data over the long run, you really don’t see much of it in recent data. The next figure plots yearly price growth against yearly wage growth over the past five years, using the hourly wage series from today’s report and the Fed’s preferred price gauge: the core PCE deflator. Not only is there no correlation, but the line goes the wrong way (faster wage growth associated with slower price growth). I wouldn’t make too much out of this; the longer-term correlation is positive. But it means we must be data driven and rigorously test all assumptions against reality.
In fact, this is really the punchline: Don’t assume anything much when it comes to these relationships between prices, wages and unemployment. Old correlations are changing all the time as the economy evolves, and anyone who tells you they know with certainty how variable X maps onto variable Y, should be summarily ignored.
What we do know is that it has taken a long time for real wage growth to reach working families in this economy. We also know that inflation is quite tame and that whatever wage or labor market pressure is ongoing, it’s not goosing prices much. All of which points to embracing, and not fearing, growing paychecks.
Update/correction: The scatter-plot above (price and wage growth) was mislabeled in an earlier version of this post. It uses only the last five years of data, not ten.