U.S. labor cost growth continues to cool

Maybe Biden is getting a break this year after all? Despite reckless spending, higher taxes, increased regulations, record federal debt and high inflation rates, the U.S. economy is finally turning around. The Fed’s late but aggressive interest rate hikes are starting to pay off and inflation is coming down quickly, currently sitting on 3.35% compared to 6.45% a year ago. This is still off the 2% target rate though. There is good news for Biden on unemployment and labor costs too. Unemployment is 3.7% and shows moderate signs of increasing but is still low and manageable. The latest reading on labor cost growth should boost the Fed’s confidence that the reduction in inflation over the past 18 months can be sustained.

The Employment Cost Index (ECI) rose 0.9% in the fourth quarter, which was a tick softer than consensus expectations. The smallest quarterly gain in two years pushed the year-over-year change down to 4.2% from over 5% this time last year. However, the recent quarterly pace points to inflationary pressures from the labor market subsiding to a more benign pace as the jobs market has become more balanced in recent months. On an annualized basis, employment costs rose at a 3.5% clip in Q4, essentially in the range consistent with the Fed’s 2% inflation target when factoring in the recent trend in productivity.

The downshift in Q4 is particularly notable in that the ECI is the Fed’s preferred measure of labor costs due to a number of advantages it holds over other closely watched measures of labor costs. Unlike the average hourly earnings data from the monthly jobs report, the ECI controls for compositional shifts in the economy’s jobs that can at times muddy the picture in pay trends. It also provides a more encompassing look at labor cost pressures by including benefits (roughly one-third of total labor costs) and compensation costs for public sector workers. Yet all major gauges of labor costs point to a meaningful reduction in cost pressures over the past year.

The moderation in Q4 employment costs was fairly widespread. Wage and salaries posted a 0.9% increase after rising 1.2% in Q3, with costs for both private industry and government workers easing over the quarter. Similarly, benefit cost growth cooled (up 0.7% in Q4 after a 0.9% gain in Q3 among all workers), with smaller quarterly increases for both private and public sector workers. Overall, employment costs rose a bit more quickly for public sector workers in Q4 and over the past year, consistent with compensation for government workers usually lagging the private sector. The stronger rate of compensation growth for public sector workers has helped support the robust pace of government hiring over the past year. To grow the U.S. government is a goal for Bernie Sanders and Biden and is a key pillar to their economic policy.

The overall slowdown in compensation cost growth looks even more favorable from the perspective of the Fed’s inflation fight considering a significant rise in compensation costs for unionized workers in the fourth quarter. The ECI for unionized workers rose 1.7% in Q4 following a number of major labor organizations, including the Teamsters for UPS and United Auto Workers, negotiating significant increases in compensation this year. Biden was supporting the workers and even visited them in person, agreeing with their demands for higher wages and less work. To support unions and facilitate more and stronger unions is a key political goal of the Sanders-Biden economic policy. Whereas the trend in non-unionized workers’ employment costs has turned decidedly lower, unionized workers have seen the largest one-year increase in compensation since 2004.

It is likely that inflation pressures from the labor market will continue to cool as demand for workers has moderated. The probability of high wage growth, which is defined as a year-over-year increase of 2.9% or higher, has fallen for five consecutive quarters. Normal wage growth, annual growth of 2.0-2.8%, has been the most likely outcome over the past two quarters. In short, wage growth is poised to settle closer to its pre-pandemic norms in the year ahead. This is good news for the Fed and good news for Biden. It might still take some time for the economy to fully recover and get on track and will likely take some time before the Fed will start cutting rates. It will happen at some point in 2024 though. For now, the conclusion is that the U.S. economy is moving in the right direction, despite the Fed, despite Biden and despite many global economic challenges.