KEY DATA: CPI: +0.1%; Excluding Food and Energy: +0.1%; Real Hourly Earnings: -0.2%; Year-over-Year: +0.3%
IN A NUTSHELL: “Despite minimal inflation, worker compensation continues to go nowhere.”
WHAT IT MEANS: The missing link remains a missing link. The lack of any gain in household spending power has restrained growth during the recovery and there are still no signs of this changing, even as inflation remains in check. Consumer prices inched up in September, which was a bit of a surprise given the sharp decline in gasoline costs. Since energy costs are viewed more as an issue of consumer spending than underlying inflation, I think the index that excludes energy is a better measure to watch. Here, prices moved up at a more moderate pace but still nothing threatening. Food costs continue to rise more rapidly than general inflation, a trend that is likely to continue for a long time as growing incomes around the world pressure prices. Medical costs are beginning to rise sharply once again and that includes commodities and hospital services. There were also solid increases in rent and vehicle maintenance and insurance costs, as well as utility piped gas, which was odd. Otherwise, prices remained well restrained. Over the year, just about any measure you can use rose by less than the Fed’s 2% target.
Despite the minimal increase in prices, earnings, adjusted for inflation, fell. An increase in hours worked offset the decline in wages and led to a gain in weekly earnings. But the reality is that over the past year, both hourly and weekly earnings, adjusted for inflation, rose by only about 0.5%. It is hard to have strong growth when spending power is largely flat.
MARKETS AND FED POLICY IMPLICATIONS: Inflation is not a major issue for the Fed as long as wage gains remain muted. That has been Chair Yellen’s talking point since she has taken over and there is little reason to think that will not be the message in next week’s FOMC statement. But there was a sign that labor shortages are on the horizon. The September state unemployment numbers were released yesterday and fifteen states now have a rate below 5%. With full employment around 5.5%, there are a growing number of markets where labor shortages have to be appearing and wage pressures building. In addition, another eight states have rates between 5% and 5.9% and they are nearing the point of no return. Since wages are not falling in above-average unemployment areas, the inevitable increases in the labor shortage locations will drive the numbers up. Compensation gains are a lagging indicator and they are trailing even more now as firms cling to the belief that they don’t have to raise wages any more than minimally. Good luck with that over the next year. As for investors, it is off to the races again as either irrational exuberance has returned or there is a growing belief that strong growth is on the horizon. I think GDP will rise well in excess of 3% next year and could exceed the 3.3% posted in 2005, making it the strongest gain in a decade, but that is not the consensus in the investing community.