Our Thoughts on 3% Wage Growth

October’s jobs report was released today, and we see several encouraging trends in the data.

Nonfarm payrolls grew 250,000 last month, beating consensus estimates for a 200,000 gain, showing that jobs growth recovered strongly from September’s hurricane-influenced slowdown. The unemployment rate stayed at a 48-year low of 3.7%, and the labor force participation rate ticked up to 62.9%.

However, investors have been hyper-focused on wage data in economic reports recently to gauge whether wage pressures will force the Federal Reserve (Fed) to quicken its pace of monetary policy tightening. Average hourly earnings grew 3.1% year over year last month, the first time that measure of wage growth has eclipsed 3% since April 2009.

While markets may be sensitive to the uptick in wage growth, we think the current pace is sustainable and healthy for the U.S. economy. We also believe data on wages should be viewed in a historical context to understand the Fed’s current approach to policy. For this, we use the Employment Cost Index (ECI) as a historical indicator of where compensation costs have been during past tightening cycles. As shown in the LPL Chart of the Day, ECI year-over-year growth has averaged 2.4% in the current tightening cycle, far below the 3.3% average rise during the Fed’s last tightening cycle.

Current Pace of Wage Growth Supports Gradual Rate Increases

“The labor market is growing solidly, and wage pressures remain at manageable levels,” said LPL Research Chief Investment Strategist John Lynch. “Since wages can represent up to 70% of total business costs, it’s difficult to have a sustainable pricing threat without much participation from wages.”

Compensation costs climbed as fast as 3.9% in the year before the Fed first hiked interest rates in April 2004, significantly above the 2.8% year-over-year increase last quarter. Wage cost growth was more benign before the beginning of the current tightening cycle, and it has remained manageable thanks to the Fed’s gradual interest rate hikes and careful policy approach.

For more analysis on the U.S. labor market and wage growth, check out next week’s Weekly Economic Commentary, which will be published November 5.

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