Wage data due out this morning could offer one of the clearest signs yet of whether the Federal Reserve’s elusive “soft landing” is still possible.
Economists forecast that total compensation costs as measured by the Employment Cost Index climbed 1.1% in the fourth quarter of 2023 from the third quarter, reaching a 5.1% annual pace. That would mark a slight slowdown in the quarterly rate from the third quarter’s 1.2% pace, but a mild uptick in the annual rate, which stood at 5% in the previous release.
Any report that is roughly in line with expectations, or even below, would come as welcome news to the Federal Reserve, which has singled out wage inflation as the most important remaining factor in its fight to slow price growth. With the cost of goods deflating and rental prices on their way down, underlying growth in services prices remains the primary outstanding source of higher inflation.
Given how higher wages push up services prices, the Fed wants to see earnings growth slow convincingly before it will begin to feel optimistic that inflation is on its way down. Many economists believe that wage growth at a roughly 3.5% annual pace would be sufficient to bring headline inflation in line with the central bank’s 2% annual growth-rate target.
“The last bit of getting inflation back into the bottle, back to target, is about getting wage growth down,” says Mark Zandi, chief economist with Moody’s Analytics. “This goes to the last mile.”
Of all the ways of measuring wage growth, the Employment Cost Index may be the best. Although it is released only quarterly and therefore lags behind the average hourly earnings data included in the jobs report each month, the ECI controls for what economists call “composition bias” and can offer a clearer view of where compensation growth is heading.
Composition bias in the average-hourly-earnings data means those figures could incorrectly show wages rising simply because a larger share of lower-income workers are losing their jobs, or falling because a larger share of higher-income workers are losing work. The ECI corrects for those distortions.
It also breaks down total compensation by category, allowing for a closer look at the pace of wage and salary growth excluding benefits, incentives, and bonuses.
That makes Tuesday’s release perhaps the most important indicator as to whether wage inflation has peaked, as other data have already suggested. Fed officials, who begin their two-day policy meeting on Tuesday morning, will examine it closely. While the report is unlikely to affect their actions this week—investors expect a quarter-point interest-rate hike—it could help determine how much further the central bank thinks rates will have to rise.
“A reading in line with our [1.0%] forecast should confirm the deceleration we’ve seen in wage growth as evidenced in average hourly earnings, and solidify the Fed’s plan to slow down and eventually pause rate hikes,” Credit Suisse economists wrote.
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