Wages are the Tail that Wags the Dog

Written by Richard Hokenson 

Is the bond market cruising for a bruising? If it reacts negatively to a preliminary estimate of 2.9% for August 2018, what will happen if October 2018 wage inflation prints with a 3 handle? The negative reaction to the 2.9% August wage inflation is reminiscent of the reaction to a 2.9% wage inflation that was initially reported for January wages in February. As we noted at that time, that uptick in wage inflation did not happen because wage gains accelerated. Instead, it occurred because the level of AHE in January 2017 was reduced, elevating the percentage comparison. Subsequently, January 2018 wages were revised lower and wage inflation was reduced from 2.9% to 2.8%. We would not be surprised if August 2018 wages were similarly reduced because the uptick is not confirmed by the Atlanta Fed Wage Growth Tracker (see Chart 1).

The markets are totally fixated on wage inflation because the opinion is that higher wage inflation must result in higher price inflation. It is not an axiom that wage inflation leads to price inflation but that is the dominant theme in the markets. The fixation is both the level of wage inflation and whether or not this month’s number is larger or smaller than the previous month, i.e.is wage inflation accelerating or decelerating? In that regard, we remain concerned that there has been no discussion of the base impact on AHE for October 2018 as there was for the March 2018 CPI, specifically the upcoming impact of the comparison to the 4-cent decline in October of last year (see Chart 2).

With respect to AHE, wage inflation accelerates if the monthly change in the current month is greater than that which occurred in the same month in the prior year. This arithmetic truism becomes relevant because there is a very strong relationship between changes in the current month compared to the year-ago month. Specifically, a “small” increase in the month in the prior year increases the likelihood of a “large” increase for the current month. Conversely, a “large” increase in the year ago month increases the likelihood of a “small” increase in the current month.

Table 1 is a chronological display of AHE developments since January 2015. Column 1 is the monthly change in cents per hour in 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 44 total observations since January 2015, there were 23 months with an acceleration in wage inflation (ratio greater than 1, see Table 4), 6 months with no difference (ratio equal to 1) and 15 observations with a deceleration in wage inflation (ratio less than 1, see Table 5).

 For the 23 months of an acceleration, the average monthly increase in the year-ago month was 3.4 cents per hour. The average monthly increase in the current month was 7.4 cents per hour, or 4 cents higher than the same month in the prior year. For the 15 months of deceleration, the average monthly increase in the year ago month was 7.3 cents per hour; 3.1 cents in the current month; with a difference of -4.2 cents.

Although there are a few anomalies, the vast majority confirm the importance of monthly changes in wages in the prior year. Therefore, a highly probable outcome for the next two months is as follows:

  • AHE increased by 12 cents per hour in September 2017. Since most big months are followed by smaller months in the following year, it is likely that AHE for September 2018 will be less than 12 cents resulting in a deceleration in wage inflation compared to August 2018. The bond market is apt to breathe a sigh of relief.
  • Wage inflation is very likely to register an acceleration for October 2018 because AHE fell in October 2017. It is very possible that 3% wage growth will be breached. We doubt that this will be handled well by the bond market.

We would be very pleased to be wrong – that our caution regarding October AHE does not materialize because AHE declines in October as it did in 2017 or that there is considerable discussion about the base effect as there was for the CPI and the markets simply take it in stride. It is something that we will continue to monitor. On a related topic, we are delighted that CPI price inflation moderated in August (see Charts 3 and 4), a development that is contrary to the notion that it is only onwards and upwards.


This update was researched and written by Richard Hokenson, as of September 21 2018