Latest / The Macro Memo with Fexingo: Daily Conversations on Inflation, GDP, and Federal Reserve Policy / Why Wages Are Rising While Inflation Stays Sticky
Transcript
- Lucas: Average hourly earnings just hit $37.50. That's up nearly 4 percent from a year ago — and it's the fastest pace we've seen in months. But core PCE is still running at 3.3 percent. So the question everyone's asking is: are higher wages keeping inflation sticky, or is there something else going on? Luna: Right, because the conventional wisdom is that wage growth feeds straight into services inflation. But the data this cycle has been messy. Let's look at the actual numbers. Lucas: Exactly. So let's start with the wage number itself. The Bureau of Labor Statistics reported that average hourly earnings for private workers rose to $37.50 in May. That's up from $37.41 in April — a month-over-month gain of 0.24 percent. On an annual basis, that's about 3.8 percent. That's above the pre-pandemic trend of roughly 3 percent. Luna: And the Fed has said they're watching labor costs closely. Chair Powell has been pretty clear that if wage growth stays above 3.5 percent, it's hard to get inflation back to 2 percent without a productivity miracle. Lucas: Right. And productivity hasn't been miraculous. Real GDP growth annualized was only 1.6 percent in the first quarter. So unless productivity surprises to the upside, that wage growth implies unit labor costs are rising. That's the classic recipe for sticky inflation. Luna: But let's break down where those wage gains are coming from. Is it broad-based, or concentrated in certain sectors? Because that matters for the inflation pass-through. Lucas: Great question. If you look at the industry breakdown, the biggest gains are in leisure and hospitality — up over 5 percent year-over-year. That's a sector where pricing power is limited, so margins get squeezed. But in professional and business services, wages are up only about 3 percent. So it's uneven. Luna: And that unevenness might be why core PCE hasn't accelerated further. If the high-wage-growth sectors are mostly low-productivity services, the pass-through to prices might be slower because those businesses just can't raise prices as much. Lucas: That's one interpretation. Another is that the wage growth we're seeing is a catch-up — workers trying to recover lost purchasing power from the 2021–2022 inflation spike. Real average hourly earnings are still below where they were in early 2021 when you adjust for CPI. So in that sense, it's not a wage-price spiral; it's a catch-up. Luna: But the Fed doesn't care about the narrative; they care about the data. And the data shows services inflation ex-housing running at about 4 percent. That's too high. And wages are a big input into services. Lucas: Right. So let's look at what the market is pricing. As of this morning, the fed funds rate is at 3.62 percent. The market is pricing in about two quarter-point cuts by December. But if wage growth stays hot and services inflation doesn't cool, the Fed might have to hold steady — or even hike. Luna: There's another piece of the puzzle though: long-term unemployment is surging. The number of people unemployed for 27 weeks or more has jumped 20 percent over the past three months. That usually puts downward pressure on wages, especially for lower-skilled workers. Lucas: That's a really important point. If long-term unemployed workers start accepting lower wages, that could cool overall wage growth without the Fed having to do anything. The question is whether that effect is powerful enough to offset the tightness in sectors like leisure and hospitality. Luna: And the May jobs report on Friday will give us more clarity. The consensus is for around 190,000 payrolls. If we get a number closer to 150,000, that might signal the labor market is softening enough to let wage growth moderate on its own. Lucas: But if we get a number above 250,000, then the wage pressure narrative gets louder. The ADP private payrolls number for May came in at 122,000 — that's actually below the whisper number, but it's not weak enough to signal a downturn. It's more like a gradual cooling. Luna: So where does that leave us? It seems like the Fed is in a tricky spot. Wage growth is still too high for comfort, but the economy is slowing. Do they cut rates to avoid a recession, or hold firm to crush inflation? Lucas: And that's the macro debate right now. I think the key insight is that wage growth is not monolithic. It's sector-specific, and the composition matters. If wage gains are concentrated in sectors where productivity can catch up, inflation might not be as sticky. But if they're in low-productivity services, the Fed has a problem. Luna: You know, this episode made me think about something. If walking through the economy with us has made something click — maybe you see the wage data differently now, or you have a clearer sense of what the Fed is watching — that's exactly why we do this show. And the way we keep it ad-free is through listener support. If today was useful, you can find us at buy me a coffee dot com slash fexingo. Lucas: Yeah, that's right. It's a small gesture that helps us keep digging into the numbers without any corporate influence. We really appreciate it. Luna: Alright, back to the data. So one more thing to watch: the Atlanta Fed's wage growth tracker is showing a deceleration in the past two months. That might be a leading indicator. Lucas: Good call. The Atlanta Fed's tracker actually fell from 5.0 percent in February to 4.7 percent in April. That's a meaningful drop. If that continues, it would take pressure off the Fed. But it's a lagging indicator — it doesn't capture the most recent data. Luna: So the bottom line? Wage growth is still elevated but showing signs of cooling. The Fed will need to see a few more months of data to be confident. And Friday's jobs report is a big piece of that puzzle. Lucas: Exactly. We'll be watching the average hourly earnings number in that report closely. If it ticks down to, say, 3.6 percent annualized, that would be a big deal. But if it holds at 3.8 or goes higher, the rate-cut narrative takes a hit. Luna: And long-term unemployment is the wildcard. If that continues to rise, it could eventually cap wage growth even if headline payrolls look strong. Lucas: Right. So we've got three things to watch: the sector composition of wage gains, the trend in long-term unemployment, and the productivity numbers. If productivity picks up, the Fed gets more room to cut. If not, they're stuck. Luna: And in the meantime, the market is pricing in cuts. The ten-year yield is at 4.54 percent, which is up 1.4 percent this week. That suggests bond traders are skeptical about cuts happening soon. Lucas: Yeah, the yield curve is still inverted. The two-year yield is at 3.62 percent, the ten-year at 4.54 percent. That's a steep inversion by historical standards. It's flashing recession, but the labor market isn't cooperating. That's a tension that has to resolve eventually. Luna: Alright, let's leave it there. We'll be back tomorrow to break down the May jobs report. If you want to support the show, again, it's buy me a coffee dot com slash fexingo. Thanks for listening. Lucas: See you tomorrow.