Labor Costs Easing, But for How Long?

The latest numbers on US labor costs in Q2 have been met with a collective shrug from economists and policymakers. The 0.9% increase in the Employment Cost Index (ECI) may seem minor compared to stronger wage growth seen in previous quarters.

Wage gains are concentrated in goods-producing industries, a sector traditionally associated with strong wage growth. However, this resurgence may be fleeting. Momentum seen between March and May fizzled out in June, raising questions about whether this was a temporary blip or a more enduring shift.

The notion that the labor market is stuck in a “low hire, low fire” state – where job growth is sluggish but wage pressures remain nonexistent – has become increasingly plausible. Economists caution policymakers not to be too reassured by this trend, as underlying dynamics are complex and multifaceted.

Wages rose 0.9% in Q2, adjusted for composition and changes in job quality. Over a longer period, the picture becomes murkier: wages have been slowing down since last year, with annual gains dropping to 3.1% – their smallest rise since the first quarter of 2021.

One possible explanation is that companies are not willing or able to pass on increased labor costs to consumers. This nuance may be more pronounced than policymakers suggest. As long as wage pressures remain muted, inflation concerns are unlikely to materialize in the near term.

The stock market reaction is telling: stocks trading lower and Treasury prices falling indicate investors are not convinced by the benign reading on labor costs. The dollar has gained versus a basket of currencies, while yields on long-term bonds have risen to 19-year highs. This suggests markets are pricing in expectations of higher interest rates – possibly even a more hawkish Fed.

The Federal Reserve continues to grapple with policy decisions, and the labor market is not providing clear signals. The “low hire, low fire” state may persist for some time yet, raising questions about the sustainability of current wage growth and inflation expectations.

Policymakers must navigate this uncertainty, but one thing is certain: the labor market remains a complex beast – full of contradictions and paradoxes that defy easy explanation. It’s unlikely we’ll see sudden or dramatic shifts in the coming months, but this uncertainty makes the current trend intriguing.

The fate of wage growth and inflation expectations hangs precariously in the balance. Policymakers will choose between erring on the side of caution – tightening monetary policy in anticipation of rising costs – or waiting for clearer signals from the labor market. The answer remains elusive, leaving us with more questions than answers about the future of the US economy.

The story of labor costs in Q2 has only just begun to unfold, with many factors yet to be revealed.