The pace of earnings growth may be gradually slowing down, but according to one of the most comprehensive measures of wage inflation, the journey back to normal is taking longer than expected by policy makers at the Federal Reserve.
Compensation Costs on the Rise
The Labor Department reported on Tuesday that compensation costs for civilian workers increased by 1.1% in the third quarter. This marks a mild acceleration from the previous three-month period and slightly surpasses consensus forecasts. FactSet economists had predicted a 1% climb in total compensation costs for the three months ending in September, matching the pace set in the preceding three months ending in June.
Deceleration in Wage Growth
However, when looking at the data on an annual basis, Tuesday’s report reveals a deceleration in wage growth. The quarterly Employment Cost Index release shows that compensation costs were up by 4.3% year over year in September. This is a decrease from the 5.2% year-over-year pace achieved in September 2022. While this represents significant progress, most economists believe that wage growth needs to slow down to approximately a 3.5% annual pace in order to align with the central bank’s target of 2% annual growth rate.
Gradual Moderation and Resilient Labor Cost Pressures
Gregory Daco, chief economist with EY-Parthenon, characterized the data as a “disappointingly gradual moderation in labor cost pressures despite broad-based evidence of labor market rebalancing.” He added that wage growth remains above the Fed’s comfort zone.
Impact on Interest Rates
The latest figures are not expected to have a significant impact on the upcoming policy meeting of the Federal Reserve. The meeting began on Tuesday and will continue until Wednesday afternoon. It is widely anticipated that the Fed will maintain interest rates at their current level of 5.25% to 5.5%. While officials had previously indicated the possibility of one more rate hike this year, most investors now expect the central bank to keep rates steady even in the December meeting.
Reinforcing the Expectation for the Fed: ECI Data Analysis
The recently released ECI data strongly suggests that the Federal Reserve may need to maintain higher interest rates for an extended period, potentially delaying any rate cuts. The main concern is the time it may take for inflation to slow down. Experts, such as Bill Adams, Chief Economist at Comerica Bank, also point out that the possibility of a rate increase in December remains on the table. The Fed worries that rapid wage growth could contribute to a resurgence in inflation next year.
One of the primary drivers of the Fed’s focus on wage growth is its impact on the cost of services. Despite the central bank’s efforts to curb economic growth, price increases in core non-housing services have remained high. However, there is a silver lining – wage growth is moving in the right direction, albeit at a slow pace. In the third quarter, public-sector employees experienced a wage growth of 1.5%, while private-sector compensation rose by a milder 1%.
Economists at Wells Fargo note that public-sector workers typically see raises after their private-sector counterparts. This implies that wage growth may continue to slow down in the coming months. While policy easing is not currently a priority, there is little need for the Fed to tighten policy further in light of the moderating trend in labor cost growth. The Wells Fargo team, led by Sarah House, states that they believe the current hiking cycle has come to an end.
In conclusion, the ECI data reinforces the expectation that the Fed will need to hold interest rates higher for an extended period. Although wage growth is gradually cooling, there is still potential for further slowdown in the months ahead. Policy easing appears to be a distant possibility, and experts predict that the current hiking cycle has reached its peak.
