Posted by: Josh Lehner | March 16, 2023

Macro Update: Inflation and Wages

Two housekeeping notes and a quick update on the current macroeconomic setting.

First, next week I will finally be getting out the historical look at regional income and poverty trends, along with regional housing burden estimates looking at residual income and the like.

Second, Census will release their 2022 population estimates for all counties nationwide on March 31st. This will be important data to track as it will allow us to get a better look at the urban-suburban-rural dynamics and how Oregon does or does not fit into patterns seen elsewhere. Unfortunately, or rather fortunately I will be out of town during Spring Break and unable to respond to the data immediately. In advance of the data, I will post more details on what our office is looking forward to seeing in the data and then follow up when I am back in the office.

Third, the Federal Reserve meets next week. Expectations were for another 0.5% (50 bps) increase in interest rates given the continued hot inflation and strong economy. Now, the bank run and collapse of Silicon Valley Bank complicates monetary policy and financial stability is paramount. Whether or not the Fed pauses (no hike next week) or chooses to go with a smaller 0.25% (25 bps) increase is to be determined. Expectations are for a hawkish pause, if you will given the economic data.

The chart below shows our office’s inflation forecast. In our document we noted that the recent inflation data to end 2022 had slowed, but also remained too high relative to the Fed’s target. The slowdown was due to more one-off factors like a decline in energy prices and a moderating of goods prices. The underlying trend remains well above something consistent with the Fed’s target. As a result we had inflation reviving in the first half of the year and staying in the 3-4 percent range for some time. Well, so far in 2023 both the January and February inflation data show this general pattern of reviving inflation, but it has happened much sooner, and much stronger than forecast. Inflation is currently running at more like a 6 percent pace. This is the main reason why expectations were for the Fed to raise rates noticeably higher in the coming months.

While economists have talked a lot about supply chains and oil shocks and their impact on inflation, rightfully so in recent years, the important underlying driver of persistent inflation is income and spending growth. The tight labor market and faster wage gains are likely to keep upward pressure on inflation in the months and quarters ahead. Here is a quick check in on one measure we follow in our office. It looks at actual employment compared to our demographically adjusted measure of the potential labor force. Unlike the unemployment rate, where the specific numbers matter, this is used as a high-level gauge of the relative strength in the labor market. Today, using the latest data that was also just benchmarked, shows Oregon’s labor market is nearly all the way back to where it was on the eve of the pandemic, and nearly higher than any other point in the past 30 years. Yes Virginia, the labor market is tight.

Ultimately we know labor income growth will slow if for no other reason than job growth will slow due to the fact there are few people available for work who do not already have a job. To date we have seen labor income slow from double-digit growth rates during the reopening period to around 7 percent today (national figures are similar). And as job growth slows in a tight labor market, total income will as well, and back to something more consistent with historical periods and hopefully more consistent with 2 percent inflation.

Note that in this forecast this still occurs even if per worker wage growth remains stronger, because job gains will taper to sub-1%. It is important to keep in mind Oregon’s potential labor force is also increasing at sub-1% rates due to the slowdown in population growth and the underlying demographics and increased retirements as the Baby Boomers age into their 60s and 70s.

Now, recent wage gains per worker are showing mixed signals. Average wages as defined as total wages divided by employment have slowed, and Oregon withholding revenues have slowed even more. On the other hand, Oregon’s average hourly earnings measure hasn’t slowed at all really and continues to boom. Even so, the closely watched measure of the national Employment Cost Index fits somewhere in the middle where the increases have slowed a little bit, they are off their peak, but still faster last quarter than anything experienced last decade.

Bottom Line: The Fed is in a tough spot. Not just due to the possible banking concerns, but due to the still hot inflation data. As opposed to the hard or soft landing, to date the economy has shown more of a no landing pattern. Nominal growth continues to be quite strong. From that perspective the Fed clearly has more work to do. We shall see how they try to balance the near-term risks with the longer-term policy goals of maximum employment and price stability.

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