Service Wages Keep Bedeviling Powell and the Markets


The Federal Reserve just got some bad news on the services sector, one of the last suspects of stubbornly high inflation in the US. That further fueled speculation that interest rate hikes still have a way to go and markets aren’t liking it.

It is understandable. A Labor Department report on Friday showed average hourly earnings for private sector service-providing jobs rose 0.6% in November from the previous month, the fastest pace since October 2021. The numbers indicate the trend rate, annualized over the last three months of data. Service-wage inflation of about 6.2% is too high for the Fed, which probably sees a sustainable non-inflation rate sitting somewhere below 3.5%. Overall hourly earnings edged down slightly, helping the goods-producing sectors, and nonfarm payrolls growth slowed slightly to 263,000 jobs in November. But service jobs are crucial.

Why focus there? As Fed Chair Jerome Powell said in his speech this week, the services sector is perhaps the most worrisome piece of the US inflation puzzle. The supply chain mess that probably started the whole mess is showing strong signs of straightening out, and many commodities and commodity prices are falling. Forward-looking measures of housing rents, another key driver of the highest inflation in 40 years, also signal moderation. But other key service categories continue to challenge the Fed, and wages are likely a big part of that. Here’s how Powell put it in his speech Wednesday at the Brookings Institution:

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This may be the most important series for understanding the future evolution of core inflation. Because wages cost the most to deliver these services, labor markets hold the key to understanding inflation in this category.

There is a perverse element to cheering for weak wage growth, which is usually associated with a soft labor market and high unemployment. There are many skeptics of the idea of ​​wage-price pass-through who rightly note that the current struggle with inflation is not caused by a tight labor market. Indeed, the decades before the Covid-19 pandemic produced many smart critiques of the once-vaunted Phillips curve, the economic model that has long suppressed the idea of ​​a link between inflation and very low unemployment.

But the late-pandemic economy was unique from previous decades in the extreme labor shortages it created, and it is logical to suspect that, for example, there would be a direct line between the price of a haircut and the cost of a haircut. Hotel workers’ earnings and vacation costs. Judging by his speech Wednesday, Powell feels the same way. In the case of this month’s data, service sector wage growth was seen fairly broadly, including a rebound in retail trade, professional services, and a recovery in health and education services, which recently showed signs of cooling in similar data.

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As always, it’s important to take Friday’s data with a grain of salt. The S&P 500 index was down 1.1%, and the yield on 10-year Treasury bonds rose 9 basis points to 3.59%, but markets essentially bounced back from an otherwise upbeat November. Ultimately, it may take more than this one report to change the market mood, and the next big catalyst may not come until the Consumer Price Index report on December 13. It’s just one month of labor market data, and the Fed is trending. To favor the Labor Department’s employment cost index for a comprehensive assessment of the compensation picture adjusted for compositional effects. (The next update to that indicator won’t be released until late January of next year, just before the Fed’s first rate decision in 2023.)

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The data trail is also filled with some signs of hope. Just a day earlier, the Commerce Department reported that the core personal consumption expenditure deflator — the Fed’s preferred gauge of inflation — rose a relatively muted 0.2% in October, including a reasonable 0.3% rise in services other than housing and energy. But with the Fed committed to curbing inflation, policymakers are likely to err on the side of doing too much rather than too little. Every time they get a piece of data like a wage gain, it reinforces their desire to stay the course.

More from Bloomberg Opinion:

• Powell and Markets talk about each other’s pasts: Mohamed El-Erian

• The Fed expects nothing less than an economic miracle: Carl W. Smith

• The Fed’s chief jobber lets the data do the talking: Jonathan Levin

This column does not reflect the opinion of the editorial board or Bloomberg LP and its owners.

Jonathan Levine has worked as a Bloomberg journalist in Latin America and the US, covering finance, markets and M&A. Most recently, he served as the company’s Miami bureau chief. He is a CFA charterholder.

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