There are an infinite number of trends for Mr. Market to consider, and here’s one more: wages are rising at a pace considerably faster than inflation. In fact, the trend has been around for a while. The question: what does it mean?
But first, the numbers. The Labor Department last week reported that average weekly earnings rose 4.5% in December on a seasonally adjusted basis–more than twice the inflation rate of 2.0% over the past year, as reported in November.
The rate of increase in wages is hardly new. Courtesy of number-crunching from NoSpinForecast.com, it’s clear that the 12-month rate of change in earnings has been moving skyward for some time. Indeed, the last time that wages were growing a more than 4% annually was in the late-1990s.
With wages growing materially faster than inflation, now’s a good time ask (again) is wages contribute to inflation? Economic theory in recent decades suggests the answer is “no.” Inflation is a monetary phenomenon and so the buck stops (figuratively and literally) at the desk of the central banks. If inflation finds a head of steam, it is only because the Federal Reserve (and its counterparts around the world) was asleep at the switch.
In theory, rising wages won’t increase inflation because an attentive central bank will nip the pricing pressure in the bud. Perhaps more importantly is the market’s perception of the Fed’s inflation-fighting credentials. If investors believe the Fed will do whatever’s necessary to stop inflation, the threat will be contained. In a world where currency is backed by faith rather than gold, perceptions count for much.
By that standard, the bond market remains optimistic that the Fed will keep inflation contained. The fear premium that bond traders demanded in early 2006 when Ben Bernanke took over from Greenspan has retreated. The 10-year Treasury yield is only marginally higher now than when the maestro gave his last performance in January 2006.
Wages, as Bloomberg columnist Caroline wrote today, is a price reflecting the value of labor. Sometimes it rises, sometimes it falls, just as it does for any other commodity or service. Higher wages “can be a symptom of inflation, rising along with the prices of goods and services. But in terms of a driver of inflation, prices lead wages, not the other way around.”
What, then, are we to conclude from the rise in wages? The labor market is tightening. Supply and demand has spoken. But while wages may not drive inflation, wage pressures may still influence the Fed’s thinking on what constitutes an appropriate price for money.
If wages continue rising at a rate that’s faster than inflation, can the Fed continue to keep interest rates steady? We know what economsts would say. How about the FOMC at the Fed? What do they think and, more importantly, how might it influence (informed or not) monetary decisions in 2007 given a labor market that seems inclined to tighten, thereby driving wages higher?
As a potential clue of what the monetary mavens are thinking, we’ll quote from the Fed minutes for December 12: “…the possibility that the tightness of the labor market could lead to sustained upward pressure on nominal labor costs was viewed as an upside risk to the expected moderation in inflation.”
So, we know that the Fed is keeping an eye on wage trends. One question investors might consider is whether the bond market is pricing in that publicly observed fact.