Falling real wages and the risk of much higher US interest rates
US wages growth is still rapidly accelerating with the employment cost index up about 4½% over the past year, which is the fastest growth since 2000 and 1991 before that.
Sharply higher wages reflect the tightness of the labour market, where the unemployment rate of about 3½% is below official and market estimates of NAIRU, and with an earlier supply shock from some workers leaving the workforce during the pandemic.
Notwithstanding faster outright growth in wages growth, real wages are still declining given wages growth has been outpaced by higher inflation.
Real wages have fallen by more than 3% over the past year, which is the largest decline since the 1970s.
This highlights the risk that households push for wage rises to compensate for the higher cost of living – something recently highlighted by the RBA – which would see a sustained pick-up in long-term inflation expectations that would threaten to entrench high actual inflation, making the Fed’s job in reining in inflation much harder.
There is no clear way of assessing this risk, but a least regrets-approach to monetary policy suggests that it is best for the Fed to quickly raise rates to be better placed if the risk to inflation expectations is realised and much higher interest rates are required (the Fed currently forecasts the funds rate will reach 2.8% next year, compared with a neutral rate of 2.4%).
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Based in Sydney, Kieran Davies joined Coolabah Capital in 2020, an asset manager than runs over $7 billion in fixed-income strategies, and is responsible for macroeconomic research and investment strategy, contributing to the investment decisions...