We have updated our mixed-frequency Dynamic Factor Model (DFM) of “common wage” based on today’s release of the Average Hourly Earnings (AHE). Today is the first time we include 2022:Q1 in the sample. (We have run the model under the preliminary assumption that AHE will growth at 5.9% YoY in 2022:Q1). The BLS report showed solid wage gains: in January, average hourly earnings for all employees on private nonfarm payrolls increased by 23 cents to $31.63. Over the past 12 months, average hourly earnings have increased by 5.7 percent.
Results of our model. Our common wage measure took signal from today’s data and revised up recent history. The estimated level of the common wage factor in Q1 (at 4.2%) is well above the pre-Great Recession period and it is comparable to the early ’90s or mid-’80s (Figure 1).
Comment. Wages are accelerating and it is hard to see a significant slowdown in the near-term. Figure 2 shows the 3m/3m at annual rate of AHE. Despite possible distortions in employment and hours shifts, the trend is clear: wage growth has (almost) doubled in the last year. Not only but given the tightness of the labor market it is hard to imagine a significant slowdown before monetary policy will start cooling off the economy. Put it differently: we are not too far away anymore from a wage-price spiral (the missing part at the moment being long-term expectations).
Implications for the Fed staff. In our view, the Fed staff monitors and forecasts AHE because it is highly correlated to the ECI wages and salaries. Given today’s data (and conditional on solid AHE gains in February and March), ECI in Q1 should also be strong. The key point is that the current pace of wage gains is well above the fundamentals: underlying inflation and structural productivity. (please, refer to our “Pre FOMC Meeting Package” for the relevant chart). In other words, the risk of a passthrough from wages to price inflation is already very high. We now expect the Fed staff to convey a clear message to FOMC members. And we expect the FOMC to act accordingly. We continue to believe that the most likely scenario is a gradual increase of the Federal Fund rates (+25bps at each meeting). However, we now think that any sign of higher long-term expectations can push the FOMC towards a more aggressive policy (+50bps at each meeting).
Figures
Figure 1. Common Factor across measures of wages and total compensation
Note: the Figure shows four measures of wages and total compensation, as well as the estimated common factor from our Dynamic Factor Model. ECI stands for “Employment Cost Index, Total Compensation, Private Industry, All Workers, SA”. AHE stands for “Average Hourly Earnings, All Employees, Total Private, SA”. CPH stands for “Nonfarm Business, Hourly Compensation, SA”. AFWT stands for “Atlanta Fed Measure of Median Nominal Wage Growth, Unweighted Overall, 3 Month Moving Average”. The four measures of wages and total compensation are shown at quarterly frequency in YoY growth rates. The common factor is specified as an autoregressive process of order 4 and it is projected onto the ECI (the measure with the lowest standard deviation). By construction, the absolute level of the estimated common factor cannot be interpreted because the four series are normalized at the beginning of estimation given their different means. Instead, the level of the common factor can be compared to its own history. Latest observation refers to 2022:Q1.
Figure 2. 3m3m at annual rate of Average Hourly Earnings (total private)
