30 Nov 2016
Strong wages gains since September strengthen the case for US interest rate hikes in December and next year, even amid a change in government.
Private hourly earnings in the world’s largest economy grew at an annual 2.8 per cent in October, the fastest pace since 2009. Because productivity growth is low, the current pace of wage increases may be consistent with 2 per cent underlying inflation, according to Macquarie Securities North America economist David Doyle.
The Federal Reserve has started to roll back the record monetary stimulus that has helped an economic recovery and underpinned financial markets since the global financial crisis. Unemployment has fallen nearly to the Federal Reserve’s defined normal level of 4.8 per cent, but consumer prices growth at an annual 1.5 per cent still lags behind its target of 2 per cent.
The election of Republican candidate Donald Trump as the 45th US President initially raised speculation the Federal Reserve could hold back from raising rates until the new government is in place. Yet, equities and the dollar have strengthened since the election, and yields on 10-year Treasuries have spiked to their highest since January, amid speculation Trump will pursue larger fiscal stimulus and higher government spending.
"The market response since the election has actually been overwhelmingly reflationary," says Doyle. "That is exactly the kind of action in the market that the Federal Reserve has been seeking. The market response to Trump’s election actually makes it more likely that we’ll see a December hike."
Of particular relevance to the outlook for inflation is the compensation trend in the construction sector, which tends to move in line with the broad economy. Earnings for non-supervisory employees in this industry grew at 5 per cent in September, the fastest since 2008.
"One of the things that has held back construction hiring for much of the last year has been an inability to find enough workers," says Doyle. "So now you are finally getting the response you would anticipate in that situation: companies are offering higher wages to attract labour."
Other trends also now point to labour supply shortages. Weekly work hours for private industry employees, the broadest measure of labour demand, rebounded sharply in September. September also recorded the strongest gains in the hiring of temporary workers recorded since 2012 and an easing in mining sector layoffs.
With the worst of an oil price slump now over, inflation may reach 3 per cent early next year, according to Macquarie. While this rate could point to tighter monetary policy, the Federal Reserve won’t rush to raise rates too quickly, says Doyle.
The pace of job market growth – steady but not fast – may allow the Federal Reserve to proceed with moderate hikes, an ideal scenario for financial markets.
Macquarie estimates a 25 basis points hike in the federal funds rate in December and two similar increases during 2017 to 1.125 per cent.
"The Federal Reserve won’t respond aggressively when you get headline inflation data that is over 2 per cent," says Doyle.
For a full copy of the report Wages, construction, & edging to full employment please contact your Macquarie representative.