Slow Progress Towards Full-Employment, Fast Rising Wages

By TRG Advisors on January 13, 2022

Inflation Must Rise Before It Can Fall

The latest inflation numbers last month were again hot and exceeded expectations – CPI at 7% y/y and core CPI at 5.5%. These are new cycle highs but to be frank, no matter the headline figures on CPI or PPI – we all know inflation is high. We know the Fed is paying attention to not only the headline but the wages and rent figures that are stubbornly high and a problem in their forecasts. We’ve talked about this at length in the past year. Inflation is high in whatever indicator you are looking at. The Fed met last week and continued onward in their more hawkish stance on monetary policy – even as they are behind the curve. Fed Chair Powell reiterated his stance on the fact that they need to move on taper faster and the need to hike rates and end the QE policies – which remain in place at $80B in bond buying until March.

Substantial Demand for Labor, Limited Supply

There are 2.9 million fewer Americans employed today than pre-pandemic, while the size of the potential labor pool has increased by 2.5 million. Translation: more jobs available, less job-seekers. The unemployment rate continues to trend downward, reporting 3.9% in December. While lower unemployment is traditionally a sign of a strong economy with plenty of demand – which is the case today – in the current environment, it also underscores the limited pool of potential job applicants that companies are competing to attract.

Chart 1: Labor Participation Rate, (Reverse Drawing) Unemployment Rate¹

The labor force participation rate measures the number of people employed or looking for work, relative to the potential labor force. The labor force participation rate, pre-pandemic, was 63.4% and now remains stubbornly below 62%. Lower labor participation is flowing downstream into reduced productivity and higher costs. One example is the severe shortage of truckers on the roads today – leading to higher supply chain costs and longer delays.

Chart 2: Employment Cost Index, Quarterly Annualized Rate²

In either Q2 or Q3 2021, the employee cost index for each of the categories above reached a 15-year high. Employees have the upper-hand as they demand higher wages to help keep up with inflationary cost pressures. One data-point that highlights this trend is the quits rate. It’s uncommon to see a high quits rate during an economic recovery when you expect individuals to be going back to work. However, the current situation of businesses offering higher, more attractive wages is resulting in a higher number of employees quitting their current jobs for the more lucrative prospects of another. The quits rate is more than 26% higher now than it was pre-pandemic.

COVID Variants Continue to Exacerbate the Problems, Draw-out the Recovery

At the onset and throughout the pandemic, older workers sought early retirement, household savings rates soared 50% (thanks in part to government stimulus), lack of available care workers required family-members to leave their jobs and care for loved ones, and COVID fears prevented many from returning to work.³ Many of these causes for lower labor participation are still in effect as the pandemic continues to impact lives and businesses.

The fast-spreading Omicron variant has significantly impacted businesses. Industries from health care to manufacturing to airlines and resorts, in the face of great holiday demand, have dealt with an impactful percentage of workers out sick. These Omicron-induced labor shortages have added further strain to a tight labor market. A stretch of depleted workforces and lower production volumes could fuel further cost increases and drive inflation. These concerns, we would argue, are in the stock market and expectations as GDP has narrowed to just 2% in 1Q. This will rebound as we work through this latest Covid variant.

In the meantime, the economy remains on solid footing: Pending home sales are back to May levels (and a leading indicator for new home sales), ISM Services and ISM Manufacturing PMIs continue to expand as significant consumer demand fuels growth. The consumer remains in good shape: balance sheets are strong, spend is 25% above pre-Pandemic levels, there are $2T in checking accounts (pent up demand), home prices, wages, and jobs remain strong. Who else should we listen to other than Jamie Dimon, the CEO of JPM – who reiterated all of these strengths. Not only is the consumer doing well, but businesses are also generating record FCF and deploying capital in efficient ways – buy backs, dividends, and capex.

¹ Source: FactSet (Chart)
² Source: FactSet (Chart)
³ Source: CNBC