“On the month, the DJIA is up 2.4%, which is more than the monthly gains in the S&P 500 (+1.6%), Nasdaq (+0.7%), and Russell 2000 (+1.4%)”–Paul Ebeling
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From the desk of Patrick J. O’Hara
The Federal Reserve has a problem on its hands, or what we should say is that it has another problem on its hands.
The first problem is knowing when it should start tapering its asset purchases. That shouldn’t be a problem. The Fed should have started tapering months ago since the conditions that drove the Fed down another quantitative easing path aren’t anywhere close to being as bad as they were when the Fed went down that path.
The other problem now on the Fed’s hands is wage inflation. It keeps showing up in the employment reports.
Distortions in the Numbers
The COVID pandemic has created a lot of distortions. That was plain to see in the average hourly earnings growth in the early stages of the pandemic. It skyrocketed as lower wage earners were disproportionately affected by job cuts when business activity cratered with lockdown/shutdown measures and stay-at-home preferences.
Average hourly earnings growth fell sharply, though, as the economy reopened more fully with the introduction of the COVID vaccines and as lower wage earners went back to work.
What the September employment report showed is that there are still a lot of people who aren’t back at work. In fact, there are 3.1 million fewer people in the civilian labor force than there were at the start of the pandemic.
It’s a confounding reality given related reports that indicate job openings are at a record high. Meanwhile, one company after the next seems to be calling attention to labor shortages as a factor that is curtailing production/service capabilities and driving up labor costs.
Those costs are going up because the supply chain issues aren’t just a commodity issue. They are also a labor issue and employers are having to pay higher wages to attract and retain workers. Higher minimum hourly pay rates at big-box retailers, like Target (TGT) and Walmart (WMT), at banks, like Bank of America (BAC), and at behemoths like Amazon.com (AMZN) are adding to the wage pressures that are trickling down to small businesses.
These aren’t going to be temporary wage increases either. They will be sticky even when the labor supply improves.
Everybody’s Doing It
Average hourly earnings were up 4.6% year-over-year in September. That wasn’t because lower-wage earners weren’t a big part of the labor mix either.
Retail trade payrolls increased by 56,000 positions in September, and leisure and hospitality payrolls increased by 74,000. Workers in these industries are making more, too. Average hourly earnings on a seasonally adjusted basis increased 3.9% year-over-year to $22.27 for retail trade and 10.8% year-over-year to $18.95 for leisure and hospitality.
In fact, average hourly earnings were up year-over-year for every private industry group, as seen in Table B-3 of the Employment Situation Report.
The 4.6% increase in average hourly earnings was the highest since February 2021, and well above the long-term average of 2.7%.
This wage inflation is going to persist — or so it seems. While supply chain issues are a problem for most companies, most companies are also still extolling the strong demand they are seeing and their ability to pass through price increases to help offset their higher costs.
So far, the price increases have been tolerated in most cases since many consumers are benefiting from excess savings, the wealth effect of rising home and stock values, and, yes, higher wages.
Still, if “everybody’s doing it” (i.e., raising prices), then the more persistent pricing pressures across a broader range of products and services are going to lead to higher wage demands to help offset those inflation pressures.
Interestingly, the 5-year breakeven inflation rate, which reflects what market participants think inflation will average in the next five years, is back at its highest level since May.
What It All Means
The unemployment rate dropped to 4.8% in September from 5.2% in August. That is the lowest unemployment rate since March 2020 as the number of unemployed workers declined by 710,000. Strikingly, there was also a dip in the labor force participation rate to 61.6% from 61.7%.
It was presumed that the labor force participation rate would be increasing since the enhanced unemployment benefits expired in September and schools reopened with an in-person orientation. What is apparent on the surface is that the expiration of the enhanced unemployment benefits didn’t convince former recipients to look for work immediately. What’s apparent beneath the surface is that childcare issues remain a headwind for the labor market recovery.
The latter has been extrapolated from the drop in the female labor participation rate to 55.9% from 56.2% in August and 57.8% in February 2020.
This drop in female participation is an important element in the scarcity of labor supply. More women returning to the labor force would help relieve some of the labor shortage, but it’s unclear if it will really relieve the wage pressures that are turning systemic and risk bleeding over into further price increases as companies try to attract workers to meet a backlog in demand.
That demand is a problem for the Fed because it encourages companies to raise prices as they battle with snarls in the supply chain and transportation bottlenecks that many think will last well into next year, if not further.
Higher prices, and increased demand among workers for higher wages to deal with those increased prices, could become a toxic policy problem for the Fed, whose hand may be forced to move more aggressively with tapering and tightening action to keep elevated inflation pressures in check.
It is a problem the Fed doesn’t want on its hands and it is a problem the stock market doesn’t want on the Fed’s hands. It’s becoming more evident, though, that it’s a problem in the making.
Have a prosperous week, Keep the Faith!