BlackRock Investment Institute

Macro insights

An eye on wages

Signs of more tepid wage growth in Friday's U.S. labour market report do not change our outlook for firming wage inflation and some more pressure on profit margins. Why? Unusually strong employment demand for a late-cycle environment is likely to provide ongoing support to wage and consumption growth.

US wage growth breakdown

BlackRock Investment Institute and U.S. Bureau of Labor Statistics, with data from Refinitiv Datastream, January 2020. Notes: This chart shows the annual change in the Employee Cost Index and the annual change of various implied components relative to their respective means from 1996-2019. The decomposition is similar to that done by former Fed Chair Janet Yellen in a September 2015 speech.

Average U.S. hourly earnings moderated to 2.9% annual rate (from a 3.3% peak in July), and the nonsupervisory component weakened for the second month in a row to 3.0% growth. Yet job creation remains substantially above the approximate 100,000 per month level required to keep the unemployment rate steady at 3.5%. U.S. payrolls expanded at 145,000 in December, taking the three-quarter average to 185,000. If this pace is maintained, the latest Federal Reserve economic projections – which show unemployment staying at current levels through 2020 – might not fully account for more labor market tightening. A reduction in global policy uncertainty as trade tensions start to ebb should boost both investment spending and hiring.

Profit margins as measured in the U.S. national accounts data (NIPA) — our preferred macroeconomic measure — could compress further. Rising wages alongside slowing productivity growth — see the chart above — have curbed corporate profit margins. Yet the tight labor market can only serve as a limited further drag on profit margins given that the unemployment rate is already well below its long-term average.

Markets are still under-pricing inflation risks, in our view. U.S. wage growth is sufficiently high to offset the rise in core consumer prices, boosting real wage increases. Core U.S. consumer prices rose 0.1% in December after climbing 0.2% in November. Translated into core personal consumption expenditures, or PCE, - the Fed's preferred gauge - US inflation is currently running close to the central banks' 2% target. A possible mild inflation overshoot is unlikely to affect the Fed’s policy stance given its focus on offsetting past undershoots – and as long as inflation expectations stay contained.