Get ready for a US “wage explosion”
US inflation is rising fast. Wages have not kept pace – but it’s only matter of time. John Stepek explains what a “wage explosion” would mean for investors.
The British newspaper headlines today are a frenzy of virtue signalling amid the arrival of President Donald Trump.
But we'll ignore the hurly and the burly and the big balloon babies. Instead, I want to focus on one of the most important trends behind today's headlines.
One of the reasons for the populist backlash in recent years has been the fact that workers feel they've been left behind, while owners of assets have made out like bandits.
Now there are signs that this might be about to turn around.
Inflation is getting ready for lift-off.
Inflation in the US is rising, however you measure it
We're going to focus on the US today because America sets the tone for global markets, and particularly for central banking. We'll take a closer look at the UK next week. But US inflation and what the Federal Reserve decides to do about it is critical to financial markets.
So it's worth noting that US consumer price inflation has reached its highest level since 2012. Prices were up by 2.9% year-on-year in June, compared to 2.8% in May. And even using core consumer price inflation, prices rose by 2.3%, an 18-month high annual rate.
The "core" measure since you asked excludes food and energy prices. That sounds stupid. After all, there are few things that matter more to our monthly shopping bills than food and energy.
But the argument goes that these prices are particularly volatile and so stripping them out gives a better idea of the underlying trend. Of course, it also serves to make the headline inflation rate look lower, which is something the world's central banks will rarely object to.
Then there's the Fed's preferred measure, "personal consumption expenditures excluding food and energy". This is even lower than core, but it's still rising at the Fed's "target" rate of 2%.
There's no sign of relief ahead either. Producer prices broadly speaking, what it costs companies to make goods or to get them into the shops are now rising at an annual rate of 3.4%. That's the highest since 2011. The cost of "freight trucking" is rising at an extraordinary 7.7% a year, notes David Rosenberg of Gluskin Sheff.
Oh, and all these tariffs won't help. The US government slapped a tariff on washing machine imports in January. As a result "laundry equipment" price inflation was up by a staggering annual 13% last month.
So however you measure it, inflation is going up fast. But there's one measure that's much more important than any others. And that's wage growth.
Wages are set to rise strongly it's only a matter of time
So far, wages in the US are rising, but not at a stratospheric rate. In fact, after inflation, wages are flat.
If prices keep rising at these rates, workers are going to notice that. And it's only a matter of time before they demand better compensation. Because they are increasingly in a position to do so.
As Barry Ritholtz notes on Bloomberg, the labour market is getting much tighter. In the US, there are now 0.9 potential staff for each job vacancy. In other words, there are more jobs than there are workers to fill them. "For context, at the height of the financial crisis the ratio was 6.6 to 1."
That suggests that if you want to get decent staff or even moderately suitable ones you're going to have to pay them more.
Of course, one way to get a significantly better wage is to dump your current job for a new one. That's exactly what's happening. Right now, more people are leaving their jobs voluntarily than at any point since they started recording the data in late 2000.
Most people who leave their jobs voluntarily are doing so because they've got a better-paid one elsewhere. So again, this shows how much tighter the market is becoming.
Finally, notes Ritholtz, the unemployment rate is rising (from 3.8% to 4% in June). That doesn't sound like a good thing, but it is. It's rising because people who had effectively once given up looking for work, have started looking again, because there are lots of jobs out there.
The fact that this can happen at all does suggest that there is still a pool of untapped workers who could decide to get back in the game, as it were. But again, it shows just how little slack there is and how much competition there should be for scarce potential employees.
Indeed, as Rosenberg points out, the big problem at this stage of the cycle is that good staff become a lot harder to find. "Skills, or shall I say a lack thereof, remain the number one concern among small businesses." The unemployment rate for the lowest-skilled workers those who didn't make it through secondary school has dropped to "an unheard-of 5.5%".
As a result, he notes, "companies are hoarding labour", which can be seen from the record-low number of redundancies being made. "But still, job-hopping has become the norm and we may well be in the precipice for a wage explosion."
A "wage explosion", eh? The workers would love that. But as Rosenberg notes, maybe not so much shareholders. Higher pay would be "good for paycheques on Main Street but less so for profit margins on Wall Street."
This is one reason why the market has struggled to go higher this year (if earnings are going to be eaten away by inflation in the future, you don't want to pay as much for them today).
But things could get a lot trickier than this. Investors should start to demand higher returns on debt, for example, making it harder for "zombie" companies to roll over their borrowing. And the Fed may end up being faced with the tough decision as to whether accelerate its slow-and-steady rate rises, or keep to the pace and run the risk of letting inflation surge even higher.
Hang on to your gold. Look for companies with pricing power (ones that can raise prices along with inflation rather than sucking up the costs). Stick with the commodity producers as they enjoy a late-cycle demand spurt. And keep an eye on the wage inflation data on both sides of the Atlantic.