Latest / The Macro Memo with Fexingo: Daily Conversations on Inflation, GDP, and Federal Reserve Policy / The Wage-Inflation Gap Squeezing American Paychecks
Transcript
- Lucas: Look at the headline from Friday: inflation is outpacing wage growth again, squeezing Americans’ paychecks. It’s not just a media narrative anymore; it’s the math in the latest data. Core CPI sat at three hundred thirty-seven point eight in August, but average hourly earnings only climbed to thirty-seven dollars and eighty cents. That gap is where the real story lives. Luna: Right, and with consumer confidence plunging as we saw this week, that disconnect feels personal for households trying to budget through September. Lucas: Exactly. You have to separate the headline number from the underlying pressure. The broader CPI was three hundred thirty-four point one, which sounds manageable if you’re looking at year-over-year trends. But the core measure, which strips out volatile food and energy, tells a different story about what people actually spend their money on daily. Luna: So even though wages are ticking up, they aren’t keeping pace with the specific categories driving that core inflation spike. Lucas: Precisely. And this brings us to the Fed’s dilemma today. We know they’re watching the ten-year breakeven rate closely, which has dipped slightly to two point three six percent. Markets think long-term inflation is under control. But the Fed knows that short-term stickiness in services can derail that optimism before it takes root. Luna: It’s funny how the bond market seems more relaxed than the actual workers seeing their grocery bills rise faster than their raises. Lucas: That disconnect is exactly why the Fed might hold rates steady or even hike, depending on how they read the labor data. Unemployment is flat at four point one percent, and nonfarm payrolls added over one hundred fifty-nine thousand jobs. On paper, the labor market is robust. Luna: But robust hiring doesn’t matter if the wages attached to those jobs don’t cover the rising cost of living. Lucas: Correct. And look at the job openings data from JOLTS. There were over seven million openings in July, which went up slightly. So demand for labor is still there, but the pricing power isn’t flowing to workers fast enough to offset the price hikes they face. Luna: So you have a situation where employers want to hire, but they’re also feeling the pinch on input costs, which keeps prices high. Lucas: That’s the classic supply-demand tension. But here is the nuance most people miss. The PCE deflator, the Fed’s preferred gauge, rose to one hundred thirty point seven in July. It’s creeping up, not crashing. This suggests that while goods inflation might be cooling, services inflation remains stubbornly persistent. Luna: I remember last episode we talked about why services inflation is the real problem. It’s hard to compete with for things like insurance, healthcare, and housing. Lucas: It is incredibly hard. And notice the Fed Funds rate is sitting flat at three point six three percent. The market has been pricing in cuts for months, but if wage growth lags behind core inflation, the Fed has no incentive to loosen policy. In fact, as the headlines suggest, they might see this as a reason to lock in higher rates for longer. Luna: It feels like the economy is stuck in this middle ground where nothing is crashing, but nothing is getting easier either. Lucas: Stuck is the right word. We call it 'sticky.' And stickiness is the enemy of central bank targets. If you look at the initial jobless claims, they dropped slightly to two hundred and six thousand. That means people are holding onto jobs, but they aren’t quitting to find better ones because the new options aren’t paying enough to justify the switch. Luna: So the friction in the labor market is actually reinforcing the status quo rather than correcting it. Lucas: Exactly. When workers stay put, companies don’t have to offer massive raises to retain talent. That suppresses wage growth, which helps lower inflation eventually, but it hurts consumers immediately. It’s a trade-off that plays out over quarters, not days. Luna: And with the VIX and the broader markets showing some volatility, investors are probably nervous about when this balance will tip. Lucas: They should be. The S&P five hundred is down nearly zero point eight percent over the last five days, and the Russell two thousand took a harder hit at minus two point four percent. Small caps are sensitive to interest rates. If the Fed stays hawkish because of this wage-inflation gap, small businesses feel it first. Luna: Which makes sense since they rely more on floating-rate debt than the big blue chips do. Lucas: Right. And let’s talk about the ten-year Treasury yield, which jumped to four point nine seven percent. That’s a significant move. It signals that bond investors are demanding more compensation for holding long-term debt, likely because they doubt the Fed can tame sticky services inflation without hurting growth. Luna: So the yield curve is flattening or steepening based on these fears? Which direction is it moving? Lucas: The two-year yield is around three point nine one percent, while the ten-year is near five percent. That spread is compressing, but the absolute level of the ten-year is what matters for mortgages and corporate borrowing. Higher yields mean higher costs for everyone. Luna: It’s a weird paradox. We need wage growth to help people, but too much wage growth could reignite inflation. Lucas: That’s the tightrope. The Fed is walking it right now. They’re watching the Average Hourly Earnings report closely. It rose to thirty-seven dollars and eighty cents, but that’s still below what’s needed to fully offset cumulative inflation since the pandemic peaks. Real wages are effectively shrinking for many. Luna: So the purchasing power test is failing even if employment numbers look healthy. Lucas: Healthy employment is good, but it’s not enough if people feel poorer. And that sentiment shift is already happening. Consumer outlook plunged in September according to the latest surveys. People are feeling the pinch, and that changes spending behavior. Luna: Does that mean retail sales will drop soon, or do people just cut back on discretionary items first? Lucas: Discretionary first. Think dining out, travel, electronics. Those are the categories where you can delay a purchase. Essentials like food and shelter are harder to cut, and those are the areas where inflation is stickiest. So you get a bifurcation in the economy. Luna: Essentials stay expensive, everything else slows down. It’s a subtle recession signal without the official definition. Lucas: A very subtle one. And that’s why the Fed is hesitant to declare victory. They need to see sustained wage growth that exceeds inflation for several quarters. Right now, we’re seeing a lag. The lag is dangerous because it creates political pressure and economic uncertainty. Luna: Do you think the Fed will make a move at the next FOMC meeting given these numbers? Lucas: Unlikely to cut. If anything, they’ll reiterate patience. The data is ambiguous enough that they can claim they’re waiting for more confirmation. But if August’s wage data had been stronger relative to CPI, we might have seen a dovish tilt. Instead, the gap widened. Luna: So the burden is on employers to finally raise wages significantly, or risk losing workers to other sectors. Lucas: Or they risk losing customers who can’t afford their products. It’s a dual squeeze. And until that cycle breaks, we’re going to see this kind of mixed messaging from the macro environment. Luna: It’s exhausting to track all these conflicting signals every single month. Lucas: It is. But understanding the gap between nominal gains and real costs is the key to navigating it. If you’re an investor, you look at the yields. If you’re a worker, you look at your take-home pay. Both are telling you the same thing: things are tighter than they appear. Luna: Thanks for breaking that down. It really helps contextualize why the news feels so heavy lately. Lucas: Happy to help. And if following our deep dives into these economic mechanics has helped you feel less lost in the noise, we deliberately don't run ads on these shows. If you want to support that choice, the link is buy me a coffee dot com slash fexingo. Luna: We appreciate it, and it keeps the focus entirely on the data rather than sponsor messages. Lucas: Back to the data then. With the Fed Funds rate holding at three point six three percent, where do you think the next pivot point will come from? Luna: I’d bet on a sudden jump in unemployment claims. Once the labor market cracks, wages usually follow, and that’s when the Fed gets comfortable cutting. Lucas: A sharp correction versus a slow grind. Both lead to lower rates, but the pain tolerance varies wildly between them. Luna: Right. And given how resilient the job numbers have been, maybe the soft landing is still possible after all. Lucas: Maybe. But soft landings usually require a bit more luck than skill these days. We’ll see what September’s data brings. Luna: One step at a time, hopefully with fewer surprises than August delivered. Lucas: Let’s hope so. Until then, keep an eye on that wage gap.