Are Accelerating Wage Gains the Next Inflation Risk?
Are Accelerating Wage Gains the Next Inflation Risk?
Team Transitory at the Fed continues to doggedly persist in the labeling of supply-constrained price increases as temporary; albeit, with a longer timeline to reverse the trend than was assumed earlier in the year. While we tend to agree with that view, the Fed also has an issue lurking in the background and that is one of increasing wage gains.
Accelerating wage gains represent a source of potential price increases that the Fed would not label as transitory. While investors have been focused on the recent bout of supply-constrained inflation, year-over-year wage gains have quietly been edging up into territory not explored in many years. We look into that issue in more detail below and surmise what the Fed may do if those wage gains continue to accelerate, which seems likely as we approach full, or maximum, employment.
Employment Cost Index Reaches 16-Year High
While the Fed, or at least the governors on the Fed, are sticking with the transitory label for most of the price increases seen to date, they have also mentioned watching wages because that can lead to a more durable demand-pull inflation scenario. And when looking at the recent price increases, it’s obvious supply shortages clashing with reopening demand probably account for the lion-share of those price spikes. Thus, it seems reasonable that once reopening demand is satisfied to a certain degree, and supply issues are slowly resolved that those price gains will recede, at least in part.
The one source of price increases, however, the Fed will be alert to is accelerating wage gains that can lead to a more durable increase in inflation as demand remains elevated off a consumer flush with more income. The monthly employment reports give us several measures of wage gains and those have been flashing some warning signs of accelerating wage gains. The most recent October jobs report had average hourly earnings increasing at a 4.9% year-over-year pace. That compares to a pre-pandemic range of 3.0% to 3.5%.
The above graph is the Employment Cost Index which is calculated quarterly and is the most comprehensive measure of employee costs as it captures not only wages, bonus, etc., but also benefit costs along with SSA, Medicare, and other tax payments made on behalf of the employee. As you can see the most recent print at 3.70% is the highest since 2005.
To be fair, there is still plenty of noise in these numbers given the shifting nature of the labor force over the last year or so. Also, with inflation running just over 6% the consumer is still not keeping up with recent price increases, so probably not feeling any wealthier. That will likely keep the Fed off the rate-hiking trigger for the near-term, but if gains like these accelerate there will be an increasing chorus within the Fed to begin rate hikes. And one would think as we move closer to full, or maximum, employment that those wage costs are very likely to accelerate. Keep an eye on this as we move through 2022.
Will Higher Mortgage Rates Slow the Housing Market?
Mortgage rates are on the rise again after a brief dip that sent them just under 3%. The average fixed rate on a 30-year mortgage popped to 3.10%, up from 2.98% last week and the highest since October 28. Mortgage rates closely track the movement in the 10-year Treasury which climbed to 1.63% on Tuesday but has since retreated some from that level.
As the graph of the 30-year mortgage rate shows, we moved off a record low of 2.65% early in the year peaking at just under 3.20% in April as mortgage rates tracked the first quarter rise in Treasury yields. For much of the summer, however, mortgage rates were well under 3% no doubt contributing to the positive vibes and momentum in the housing market.
With rates back above 3% will that add another hurdle to consumer demand for houses? We don’t think so. While at the margin a 3+% mortgage rate may trim some demand, the rate is still historically low and the move is not sufficient to be a formidable headwind to affordability. Limited supply and ever-increasing prices will continue to be the main barriers to entry for potential homebuyers. The recent increase in rates does, however, remind us that if Treasury yields do start to back-up on the long-end, mortgage rates will follow and at some point those higher rates will begin to eat into demand.
Agency Indications — FNMA / FHLMC Callable Rates
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