Investors confident about the likelihood of easing U.S. inflation may be failing to put enough emphasis on one key component of last Friday’s surprisingly strong jobs report for December.
It’s average hourly earnings, which rose by 0.4% for the month and by 4.1% year over year, beating expectations. On Monday, Brent Schutte, chief investment officer of Milwaukee-based Northwestern Mutual Wealth Management Co. — which oversaw $255.7 billion as of the end of September — described wages as “the one remaining ember that could reignite inflation.”
A lot is riding on getting the path of inflation just right in the year ahead, starting with traders’ expectations for multiple interest-rate cuts by the Federal Reserve. Those rate-cut hopes are now coalescing around five to seven quarter-point reductions by year-end, and they have remained largely intact even after December’s nonfarm-payroll report showed the U.S. added a solid 216,000 new jobs and the unemployment rate remained flat at 3.7%.
“We believe now, unfortunately, a tight labor market and wage pressures could fuel inflation going forward,” Schutte wrote in a note on Monday. History suggests that the Fed views 3.5% annual wage growth “as the upper limit the economy can absorb” while still achieving a 2% annual inflation rate.
The next major U.S. inflation update arrives on Thursday, with December’s consumer-price index expected by economists to show the annual headline inflation rate ticking slightly higher, to 3.3% from 3.1% previously. That’s down from a 9.1% peak in June 2022.
Although the Fed has recently touted its progress in bringing inflation under control, “it remains wary that the continued tight job market could cause a repeat of the period of embedded high inflation from 1966 until 1982, a period characterized as being driven by a wage-price spiral in which rising wages were used to pay ever-rising prices,” Schutte said. This “nagging concern” is reflected in the minutes from the Fed’s December meeting, where policy makers saw uncertainty around their outlooks for lower interest rates and failed to rule out further hikes.
As of Monday, investors largely continued to express confidence in a soft-landing outcome for the U.S., in which inflation can keep falling without a recession. Two-
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and 30-year
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Treasury yields dropped for the first time in three sessions after a December New York Fed survey showed consumer expectations for inflation declined for all time horizons.
Meanwhile, U.S. stocks
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finished higher, led by a 2.2% jump in the Nasdaq Composite. In addition, strategists at UBS Group’s wealth-management arm joined a growing chorus on Wall Street that expects the benchmark S&P 500 to reach record territory before year-end.
Analysts at BlackRock Inc.’s in-house research arm, however, said sticky U.S. wages are the reason they think “market optimism on inflation may eventually be let down.” They said that a tight labor market is “driving stubbornly high wage growth, as seen in the December jobs data,” and inflation is set to go on a roller-coaster ride.
In a note on Monday, Jean Boivin, head of the BlackRock Investment Institute, and others said they see more volatility ahead in fixed-income markets “partly as inflation’s persistence becomes clearer.” BlackRock is the world’s largest asset manager, overseeing $9.1 trillion in assets as of Sept. 30.
This story originally appeared on Marketwatch
