The (very slowly) growing reward for a hard day’s work

by: , Managing Director, Economist, and Portfolio Manager, New York Life Investment Management

We’ve commented previously on the peculiar breakdown in the relationship between employment levels and wage growth. The tendency for wage pressures to build as unemployment rates fall, observed by economist William Phillips and hence known as the Phillips Curve, has intuitive appeal: as the number of available workers falls, prospective employers must compete for talent by bidding up wages.

The basic model

Source: Tutor2u.org. 6/14/18. This is a theoretical depiction of the relationship between the unemployment rate and the inflation rate which can be considered wage inflation or consumer price inflation.

That logic should presumably apply today, yet it is difficult to see in the data

Last week brought us the latest edition of the JOLTS report (Job Openings and Labor Turnover Survey) from the Bureau of Labor Statistics. For the first time in the eighteen-year history of the series, there were more job vacancies reported than there are unemployed workers available to fill those positions.

Job openings and hires (U.S. total)

Source: Bloomberg 6/14/18.

Also at a decade high was the Quits Rate, referring to the percentage of the workforce that voluntarily left their positions, presumably because they have found alternative employment on more attractive terms.  At the very start of the month we learned that the unemployment rate has fallen to an estimate 3.8%, matching the lowest reading in almost 50 years (April ’00 was the only other observation that low since 1969).  And the National Federation of Independent Businesses reports a record number of firms that have positions they have been unable to fill.  So, we have multiple reliable indicators all telling the same story: the demand for labor is outstripping available supply.

U.S. quits rate

Source: Bloomberg 6/14/18.

That being the case, we would expect to see compensation levels rising rapidly.  No so.  The growth rate in average hourly earnings has been picking up gradually over the past several years, but it has held stubbornly below 3%.  Demographics may be contributing to this phenomenon as high earning Boomers are retiring and being replaced by low earning Millennials, depressing readings on aggregate compensation.  But even adjusting for that effect, as the Atlanta Federal Reserve Bank attempts to do with their Overall Wage Growth Tracker Index, compensation growth remains subdued, moving from very low to less low.

Atlanta Fed Wage Growth Tracker Overall

Source: Bloomberg 6/14/18.

The upshot

While the labor market is now tight by many standards, it may take an even tighter labor market, and thus an even lower unemployment rate, to push wage growth and inflation up in a material way. The economic expansion has more room to run.

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About Risk

All investments are subject to market risk, including possible loss of principal. There is no assurance that the investment objectives mentioned will be met. Diversification cannot assure a profit or protect against loss in a declining market.

The Atlanta Fed’s Wage Growth Tracker is a measure of the nominal wage growth of individuals. It is constructed using microdata from the Current Population Survey (CPS), and is the median percent change in the hourly wage of individuals observed 12 months apart.

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Poul Kristensen, CFA

Managing Director, Economist, and Portfolio Manager, New York Life Investment Management

Poul Kristensen, CFA is Managing Director, Economist, and Portfolio Manager with New York Life Investment Management’s Strategic Asset Allocation & Solutions (SAS) Group

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