Employment, Wages, and the Fed

Don’t put the cart before the horse!

Source: Edublogs

That’s what I thought when I heard that the Fed is targeting wages as an economic indicator. Over the past several years hourly earnings have been stagnant. Some say the Fed shouldn’t raise rates until household income improves. And since real wages haven’t moved, Fed policy should stay where it is. Only in the past couple years have wages begun to outpace inflation.

Global Market Update - Real Hourly Earnings

Source: Economic Report of the President, 2015

But wages are a lagging indicator. Before employers raise wages, they need to hire more workers. Activity precedes price: housing prices only go up after home sales increase. Movie tickets only get more expensive after theater traffic increases. So for real wages to improve, employment has to pick up. Fortunately, that’s exactly what we’ve seen lately.

Global Market Update - Average Monthly Nonfarm Employment Growth

Source: Economic Report of the President, 2015

Employment growth has moved decidedly higher. In the last three months of 2014 over a million jobs were created. Sure, if you look at month-to-month changes it can be hard to filter out the noise, but the longer-term trend is clear: the pace of job-creation has picked up, unemployment is moving down, and earnings will advance.

Janet Yellen is a labor economist. She should emphasize this in her testimony to Congress next week. Activity precedes price. Wage growth will follow job growth. And the Fed needs to be ready.

Douglas R. Tengdin, CFA
Chief Investment Officer
Phone: 603-224-1350
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