US wage growth set to accelerate

18 May 2018

US wage growth, which has underperformed expectations for much of the past decade, may be poised to accelerate this year.

Falling unemployment, rising commodity prices and diminishing labour slack means average hourly earnings will increase at a pace more in line with an expanding economy, says Macquarie North America economist David Doyle.

“The headwinds for wage growth have now faded," he says.

In the past, a drop in the unemployment rate below 6 per cent was followed by higher wages six months later. In the current cycle, the 6 per cent threshold was reached in November 2014, yet earnings growth has remained subdued.

Two Bureau of Labor Statistics wage growth measures - one covering all private workers, the other production and non-supervisory workers – have remained below 3 per cent since 2009. Doyle expects both measures to climb to 3.75 per cent by the end of 2019.

Headwinds to wage growth

A number of factors have restricted wage growth, including a high number of baby boomer retirees replaced by cheaper workers, and a significant drop in oil prices in 2015 and 2016 which kept headline inflation low and made nominal wage growth appear soft.

In addition, the global financial crisis led to a large labour slack unaccounted for in the headline unemployment figure.

The large excess slack outside of the labor force was a key factor in limiting wage growth. And that slack is now dissipating into the rear-view mirror.

That slack has diminished. The share of potential workers who want a job but are outside the labour market fell in March to its lowest level since 2008. Those unemployed for six months or longer are at a new cycle low. The employment-to-population ratio among those aged 25-54 has risen to levels seen in 1994 and 2004, when a pick-up in wage growth ensued.

“While previously the core unemployment rate was the determinant for wage growth, this time the large excess slack outside the labor force was a key factor," says Doyle. “And that slack is now dissipating."

Lower unemployment, higher interest rates

Even as the pace of job creation decelerates, Macquarie estimates the US economy will add an average 150,000 non-farm jobs a month in 2018, more than double what is required to keep pace with labour force growth.

“Labour demand growth should continue to significantly exceed labour supply growth, adding persistent downward pressure on the unemployment rate through 2019 and upward pressure on wage growth," says Doyle.

Doyle forecasts the headline unemployment rate will fall from its current level of 4.1 per cent to 3.6 per cent this year and 3.3 per cent in 2019, the lowest trough reading for a cycle since the 1950s.

Lower unemployment will prompt the Federal Reserve to raise interest rates four times in 2018 and a further three to four times next year, says Doyle. He lifted his estimate for the number of rate increases in February following strengthening job creation data.

For a copy of the report, The US Economy, Oil, and Overheating, contact your Macquarie representative.

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