Wages are the Central Issue for 2018

Written by Richard Hokenson 

The U.S. Fed is projecting further increases in interest rates because they believe that the economy is very close to full employment - wages should begin increasing any second now which will lead to higher price inflation. Our (Hokenson & Company) view is that there is still considerable labor force slack which will continue to translate in modest wage inflation. This is confirmed by the relationship between the unemployment rate and wage growth as measured by the Employment Cost Index (ECI). Wage inflation has hardly budged despite a substantial decline in the unemployment rate (see Chart 1). The same pattern is also evident in Average Hourly Earnings (AHE), which recorded a deceleration in 2017 (see Chart 2). A similar deceleration was also evident in the Atlanta Fed’s Wage Growth Tracker – 3.3% for 2017 versus 3.5% in 2016. We are also encouraged by the fact that nearly every day there is a news story regarding firms recruiting employees that had been passed over before, e.g. those with prison records. Barring any shocks to labor supply, e.g. bigger declines in the number of foreign born workers, we remain of the view that wage inflation will remain moderate in 2018.

Price Inflation

With respect to the outlook for core CPI inflation, several commentators are forecasting higher price inflation in 2018 based at least in part on the observation that the “base effect” will help, i.e. when the March 2017 decline, which partially reflected mobile phone prices, drops out. Left unsaid, however, is the fact that the monthly increase in the core CPI was lower in 7 of the remaining 9 months of 2017 (see Chart 3). While it is true that the March dip caused the core CPI inflation rate to drop from 2.22% in February to 2.00% in March, the cumulative effect of the remaining months carved out another .22% from the inflation rate as measured yearon- year (see Chart 4).

While it is very likely that the results for March 2018 will show a higher year-on-year change compared to February, the actual result is apt to disappoint relative to current expectations. Last but certainly not least with regards to the outlook for inflation is the fact that there is now a strong rebound in productivity (see Chart 5) which is resulting in a decline in unit labor costs (see Chart 6). Yet another reason to be sanguine regarding the outlook for inflation this year.

Outlook for the Fed

In the belief that higher wage inflation was just around the corner and that the weakness in inflation was transitory or a flue, the Fed raised interest rates three times last year. That belief, however, will certainly be tested if wage growth remains moderate and price inflation does not spike up. Will they stick to their plan for three increases this year or will continued moderation result in a different appraisal? We hope for the latter.


This update was researched and written by Richard Hokenson. Data is as of 18 January 2018

This article represents the views, opinions and recommendations of the author(s) regarding the economic conditions, asset classes, securities, issuers or financial instruments referenced herein. Distribution of this information to any person other than the person to whom it was originally delivered is unauthorised, and any reproduction of these materials, in whole or in part, or the divulgence of any of the contents hereof, without prior consent of Pricoa Capital Group is prohibited. Certain information contained herein has been obtained from sources that Pricoa Capital Group believes to be reliable as of the date presented; however, Pricoa Capital Group cannot guarantee the accuracy of such information, assure its completeness, or warrant such information will not be changed. The information contained herein is current as of the date of issuance (or such earlier date as referenced herein) and is subject to change without notice. Pricoa Capital Group has no obligation to update any or all of such information; nor do we make any express or implied warranties or representations as to the completeness or accuracy or accept responsibility for errors. These materials are not intended as an offer or solicitation with respect to the purchase or sale of any security or other financial instrument or any investment management services and should not be used as the basis for any investment decision. Past performance is no guarantee or reliable indicator of future results. No liability whatsoever is accepted for any loss (whether direct, indirect, or consequential) that may arise from any use of the information contained in or derived from this report. Pricoa Capital Group and its affiliates may make investment decisions that are inconsistent with the recommendations or views expressed herein, including for proprietary accounts of Pricoa Capital Group or its affiliates.

The opinions and recommendations herein do not take into account individual client circumstances, objectives, or needs and are not intended as recommendations of particular securities, financial instruments or strategies to particular clients or prospects. No determination has been made regarding the suitability of any securities, financial instruments or strategies for particular clients or prospects. For any securities or financial instruments mentioned herein, the recipient(s) of this report must make its own independent decisions.