Fed's key wage inflation metric tops forecast

REAL ECONOMY BLOG | October 31, 2023

Authored by RSM US LLP

The employment cost index has been the Federal Reserve’s top indicator for wage pressure on underlying inflation recently. That figure for the third quarter showed that labor costs rose 1.1% higher than the forecast of 1.0% and were higher than the pre-pandemic average of 0.6%.

The hotter-than-expected increase told a different story than what other wage growth measures—unadjusted for job compositions—such as hourly wage rate or unit labor cost have pointed to.

The stickiness of wage inflation data came only one day before the Fed makes its next decision on interest rates, presenting a challenge particularly for Chairman Jerome Powell in his news conference on how to strike a hawkish tone when most likely we will see the Fed hold rates steady.

On top of that, with most forecasts pointing to a material slowdown in the final quarter, the Fed will have a difficult task to strike a balance between focusing on inflation and supporting economic growth without appearing too dovish, a recipe for a potential rebound in inflation earlier than desired.

What should work in the Fed’s favor was that a lot of the increase in the cost index was driven by government jobs, which grew by 1.5% in the quarter, while the private sector saw a 1.0% increase.

With the risk of a government shutdown looming, we should expect government wage growth to face more challenges.

In a separate report, the Conference Board’s consumer confidence index dropped slightly in October to the lowest level since June.

More troubles for the Fed were the sharp upticks in inflation expectations for the next 12 months. The survey respondents saw a median of 5.0% for headline inflation, higher than 4.8% in September. The rebound in energy prices and overall inflation due to robust demand were important factors.

However, the labor differential index, which is a measure of the difference between respondents who said jobs were plentiful and jobs were hard to get, improved on the month, adding reasons to expect a solid jobs report coming on Friday.

We expect October’s net change in payroll to be around 160,000, about half of September’s figure, yet remaining much stronger than what the Fed is aiming for at 100,000 monthly. The UAW strike, together with other major ongoing strikes, will be a significant drag on employment in October.