Implications of the November Miss on Wages

Written by Richard Hokenson 

The smaller than expected increase in Average Hourly Earnings (AHE) for November (6 cents per hour versus anticipations of 7 cents per hour) increases the probability that December wage inflation to be released on January 4, 2019 will surprise to the downside, i.e. wage inflation will come in below 3%. Barring revisions to prior months, wage inflation for December will dip to 2.9% if the monthly increase is 7 cents per hour. A monthly gain of 4 cents per hour would mean wage inflation will dip to 2.8%.

The conclusion that December wage inflation is highly likely to decelerate is based on proper incorporation of the base effect. A big base, i.e. “large” monthly increases in AHE in the year-ago month result in smaller gains in the current month. It is still a puzzle that the base effect was properly discussed with respect to the March CPI, but not with AHE. AHE increased by 10 cents per hour in December 2017 (see Chart 1). As detailed below, In the previous seven months since January 2015 with monthly increases of 9 or more cents per hour, 6 had smaller increases and 1 was unchanged.

A deceleration in wage inflation should at least give pause to the conventional wisdom that it is always onward and upward. The same is true for price inflation. The average monthly increase in the core CPI thus far this year is the same as it was in 2016 (see Chart 2) with the core PCE deflator slightly below 2016 (see Chart 3). Signs of overheating are still difficult to spot. Wage growth is sluggish by historical standards. We believe that the recovery has longer to run. We hope that is a sentiment that is shared by the Federal Reserve.

Wage Inflation Specifics

The markets are principally focused on wage inflation which is measured as the percent change this month versus the year-ago month. While there is some emphasis on the level of wage inflation, the more important focus is on wage inflation this month compared to the prior month, e.g. is it stable, accelerating or decelerating? Wage inflation accelerates if the monthly change this month is greater than that which occurred in the same month in the prior year. As detailed in the tables below, this arithmetic truism becomes relevant because there is a very strong relationship between changes in the current month versus the change in the year-ago month. A “small” increase in the year-ago month raises the likelihood of a “large” increase in the current month – wage inflation this month will show an uptick relative to the prior month. Conversely, a “large” increase in the year-ago month increases the probability of a “small” increase in the current month –wage inflation will show a downtick.

Table 1 is a chronological display of AHE developments since January 2015. Column 1 is the monthly change in cents per hour for the same month in the prior year. Column 2 is the monthly change in the current month in cents per hour. Column 3 is the difference. Column 4 is the wage inflation rate in the current month; column 5 is wage inflation in the prior month. Column 6 is the ratio between them. A ratio above 1 indicates that wage inflation accelerated; below 1 is a deceleration. For example, the first row of Table 1 refers to AHE for January 2015. For that month, AHE increased by 5 cents per hour in January 2014 (year-ago month for January 2015). The increase in January 2015 (current month) was 10 cents per hour, or 5 cents per hour greater than a year ago. Wage inflation increased by 2.19% compared to 1.99% in December 2014, making the ratio 1.10.

Table 2 sorts the results by cents per hour in the year-ago month (smallest to largest). Almost all of the small increases in the prior year had larger increases in the current year which is confirmed by Table 3 which sorts the results by the ratio of wage inflation this month compared to the prior month.

Of the 47 total observations since January 2015, there were 24 months with an acceleration in wage inflation (ratio greater than 1, see Table 4), 7 months with no difference (ratio equal to 1) and 16 observations with a deceleration in wage inflation (ratio less than 1, see Table 5).



This update was researched and written by Richard Hokenson, as of December 13 2018