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Average Hourly Earnings came in strong in December, as expected by our model. The model now expects a very soft reading (can round to 0.2% MoM, sa) in January. Last month (see our note here) our model predicted a 0.4% (to rounding) MoM sa in December. The data came in just a touch stronger than the model expected ex-ante, and the fitted values explains virtually the entire ex-post (that is once the model is allowed to see the realized explanatory variables) monthly variation in December. The same model predicts a very low MoM sa reading in January (0.258%), driven by a large contribution of “residual calendarity”.
(A PPT containing all US wage charts has been updated and posted here)
A preliminary note
Average Hourly Earnings rose 44bps in December. The reading is driven by a large, positive contribution of “residual calendarity”, as expected. In December, there are no visible distortions from seasonal adjustment issues as in previous months (see here). Rather, the solid December reading is driven by a large, positive contribution of “residual calendarity”: December had 10 weekend days vs 8 in November. The contribution of shifting shares of employment across sectors is small.
Note: if the reader is unfamiliar with the notion of “residual calendarity” in AHE space, (s)he can refer to this BLS page, and to our previous notes here, here, and here.
The AHE model
The “true” AHE pace is around 4% (ar), going sideways. Figure 1 shows an update of our AHE monthly model. As a reminder, this model explains monthly AHE growth rates using recent past, a variable capturing “residual seasonality”, a variable capturing economic “slack”, and sectoral employment shares. In December (latest point on the chart), the fitted value of the model is nearly identical to the published AHE growth rate: 42bps vs 44bps. In other words, once the model is allowed to see the realized explanatory variables, it is able to fully explain what happened last month. Specifically, the strong MoM in December is explained by a large, positive contribution of “residual calendarity” (December had 10 weekend days vs 8 in November), a positive boost from the autocorrelation property of the series, and a tiny push from sectoral share shifts. Having said that, an important information in Figure 1 is that the fitted values (blue line) are going roughly sideways, as argued in recent months. In other words, correcting for residual calendarity effects and sectoral employment shifts, the model suggests a limited (in any) disinflation in AHE growth in the last year, consistent with the signal from the labor market.
Figure 1. AHE MoM (sa) and UnderlyingInflation AHE model fitted values.
Note: the figure shows published MoM (sa) AHE growth rates (orange line) and UnderlyingInflation AHE model fitted values (blue line). The figure excludes the first 6 months of Covid for scaling issues (although they are included in the model estimation).
Why sectoral shifts are crucial. We often get the following question: how important are sectoral employment shifts for AHE growth? Figure 2 clarifies why it is very important to control, somehow, for sectoral employment shifts. Figure 2 shows the published AHE YoY growth rate (the yellow line), and the share of employment in industries with AHE level above the aggregate mean. Figure 2 is not meant to say that industry shifts can explain everything. Rather, it is just a reminder not to take at face value the MoM (or YoY) of AHE when it pops up on your Bloomberg terminal. Indeed, as shown in Figure 1, the disinflation in AHE space in the last year, once industry mix distortions are taken into account, is very limited according to our model.
Figure 2. YoY of AHE and Sectoral Employment Share.
What to expect in January (and in Q4 ECI)
Very LOW AHE in January, solid Q4 ECI. According to the model, AHE MoM (sa) growth in January assuming that the sectoral shares will stay constant is expected to be 0.258%. Therefore, there is a real chance to get a 0.2% MoM (sa) to rounding next month for AHE. The reason is that the “residual calendarity” effect that has boosted the December MoM reading will flip sign next month (January has 8 weekend days vs 10 in December). As for the ECI, we expect a Q4 figure around 4%+ (QoQ saar), showing limited or no deceleration.
Conclusion and implications for the Fed
Wage growth remains very solid and above the pace consistent with the 2% target. In fact, current wage growth is more consistent with 3% than 2% in consumers prices space. The analysis contained in this note reinforces the case for a prudent Fed until there will be evidence we can go back to 2%.