Jobs bounce back, but labor costs point to tame inflation

Invesco Fixed Income expects continued strong job growth, solid economic growth and two more Fed rate hikes in 2017

Jobs bounce back, but labor costs point to tame inflation

After a disappointing March, strong April employment data — announced May 5 by the Department of Labor — have confirmed that US labor market slack is shrinking and the economy is growing steadily. According to Invesco Fixed Income’s estimates, the addition of 211,000 jobs in April is consistent with overall economic growth of around 2.5% in 2017. The April unemployment rate fell to 4.4% and underemployment came in at 8.6%, close to the cycle lows of the mid-2000s. But mixed underlying wage growth leaves market participants questioning whether or not wage pressures are materializing.

Wage growth is an important factor in the Federal Reserve’s (Fed’s) interest rate decision-making process. It is a major driver of so-called “cost-push” inflation — a primary focus as the Fed seeks to fulfill its mandate to maintain steady inflation.

There are several problems, however, with measuring wage growth in real time. First, the well-known average hourly earnings number that is released along with the monthly jobs report tends to be unreliable. It can be distorted by changes in the composition of the labor force and may not reflect underlying labor slack.1 The Fed’s preferred measure of wage growth is the “Employment Cost Index,” which details changes in businesses’ cost of labor and provides a more accurate measure of labor slack, but it is only released quarterly and with long lags.2

Tracking wages in real time

To overcome these challenges, Invesco Fixed Income has developed an indicator based on a broad measure of high-frequency data that seeks to measure the Employment Cost Index in real time. Our measure is based on timely survey data, normalized measures of wage growth (in other words, measures that are not affected by changes in labor force composition), and economics-based leading indicators.

Based on our estimates, we do not see a significant acceleration in wage growth, as shown in Figure 1. Rather, regional Fed surveys and business and consumer confidence all point to steady wage growth. This is consistent with the normalized monthly wage growth figure provided by the Atlanta Fed and the “quits rate” from the monthly Job Openings and Labor Turnover Survey (JOLTS) of labor market conditions, as shown in Figure 2.3

The quits rate is our preferred forward-looking wage indicator. Several lines of research indicate that wages closely track peoples’ propensity to leave their current job for a new one.3 We have found that the quits rate tracks that dynamic and tends to lead wages. As shown in Figure 2, the quits rate has remained range-bound since mid-2015.

Figure 1: Invesco Fixed Income real-time wage tracker versus the private wage component of the Employment Cost Index

Employment Cost Index

Source: BLS, Bloomberg L.P., Macrobond, Invesco calculations, data from April 30, 1998 to Feb. 28, 2017, Invesco Fixed Income Wage forecast to July 31, 2017.

Figure 2: The quits rate from the JOLTS survey compared to the Atlanta Fed’s median wage growth indicator

quits rate

Source: BLS, Bloomberg L.P., Macrobond, Invesco calculations, data from April 30, 2002 to March 31, 2017.

It may be surprising that wages remain subdued, given the current low unemployment rate and the general consensus that the labor market has likely reached full employment — a view we share. However, our research suggests that older demographics and low productivity have dragged down the normal rate of annual wage growth from around 3.5%‒4.5% before the global financial crisis in 2008‒2009 to around 2.5%–3.5% post-crisis (Figure 1).

Implications for inflation

We, therefore, do not expect wages to put pressure on inflation in the near term, as they have in past recoveries. We expect inflation to be rather steady for 2017, ending the year at around 2.2%, generally in line with the Fed’s target. We also expect the consumer to be supported by continued strong job growth, resulting in solid overall economic growth. Based on our constructive growth and inflation outlook, we expect the Fed to stay on schedule for two interest rate hikes this year. We do not believe these hikes will be disruptive to financial markets, as they have been largely priced in by the bond markets. Therefore, we expect US credit assets to be well-supported by stronger fundamentals as the Fed gradually moves forward on its tightening path.

1 Source: Daly, Hobijn and Pyle. “What’s up with wage growth?” FRBSF Economic Letter. July 2016.

2 Source: Janet Yellen. “Current conditions and the outlook for the U.S. economy.” At the World Affairs Council of Philadelphia. June 6, 2016.

3 Source: Daly, Hobijn and Wiles. “Dissecting Aggregate Real Wage Fluctuations.” FRBSF Working Paper, 2011‒23. May 2012.

Important information

Blog header image:

Cost-push inflation is when prices rise due to increases in wages and raw materials prices.

The quits rate illustrates the number of quits during a month as a percent of total employment.

The Employment Cost Index details changes in US businesses’ cost of labor. It is prepared quarterly by the Bureau of Labor Statistics. An investment cannot be made into an index.

Past performance is no guarantee of future results.

Jay Raol

Senior Macro Analyst

Jay Raol is a Senior Macro Analyst for the Invesco Fixed Income team. He is involved in quantitative analysis and supports investment strategies across the group.

Mr. Raol entered the investment industry in 2010. He joined the Fixed Income team in 2013, after previously working as an equity risk analyst at Invesco.

Mr. Raol earned a BA and PhD in computational and applied mathematics from Rice University.

Noelle Corum, CFA

Macro Analyst

Noelle Corum joined Invesco Fixed Income in August of 2010 and is involved in derivatives, FX and rates trading, macro view implementation and asset allocation.

Ms. Corum began her investment professional career at Invesco following her undergraduate studies.

She earned a BS degree in business administration, with a concentration in financial analysis, from Saint Louis University, where she minored in mathematics and earned a certificate in service leadership.

James Ong, CFA

Senior Macro Strategist

Derivative Portfolio Manager

James Ong is a Senior Macro Strategist and a Derivative Portfolio Manager for Invesco Fixed Income. Mr. Ong contributes economic and market analysis to the Macro Research platform. Mr. Ong leads IFI derivative strategy and oversees derivatives held in IFI portfolios.

Mr. Ong began his investment career in 2001. Prior to joining Invesco in 2014, he was a senior vice president, a senior portfolio manager and a senior trader at Hartford Investment Management Company.

Mr. Ong earned his BA degree in economics from Middlebury College. He is a CFA charterholder.

More in Fixed Income
GDP growth dims, but we see bright spots ahead
GDP growth dims, but we see bright spots ahead

US gross domestic product (GDP) rose only slightly in the first quarter, but this result was in line with Invesco Fixed Income’s expectations and we...