Latest / The Macro Memo with Fexingo: Daily Conversations on Inflation, GDP, and Federal Reserve Policy / Why Wage Growth Is Fueling Sticky Inflation
Transcript
- Lucas: Look at the average hourly earnings number from July. It sat flat at thirty-seven dollars and sixty cents, but when you strip out the one-off effects of last month’s contract negotiations, the underlying trend is ticking up again. Luna: Right, and that matters because services inflation is almost entirely driven by wages, so if labor costs keep rising, prices follow. Lucas: Exactly. We have core PCE creeping up to one hundred and thirty point seven, which is still above the Fed’s two percent target on an annualized basis. The problem isn't that inflation is exploding; it's that it's refusing to die. Luna: But wait, didn't we just talk about how factory weakness should cool things down? Why aren't we seeing that drag yet? Lucas: Good question. Manufacturing has been soft for months, with China’s factory activity shrinking for a second straight month, but the US service sector is surprisingly resilient. And inside that resilience is the labor market. Luna: So you’re saying the goods side is deflationary but the services side is keeping the heat on? Lucas: Precisely. That’s the bifurcation. Goods prices are stabilizing because supply chains have fixed themselves, but services rely on people, and people want higher pay. Look at the JOLTS data: job openings actually rose to seven thousand two hundred and seventy-one thousand in July, even as nonfarm payrolls ticked down slightly. Luna: That’s the weird part — fewer jobs created but more openings available? That suggests employers are hesitant to hire permanently but still desperate to fill seats. Lucas: It signals a tightness in specific niches. Healthcare, hospitality, and professional services are still struggling to find workers, which forces them to raise wages just to maintain headcount. And those wage hikes get passed on to consumers in the form of higher fees for haircuts, medical visits, and dining out. Luna: Which brings us back to the Fed. If wages go up, do they cut rates anyway? Lucas: They might be forced to. The Fed Funds effective rate is holding steady at three point six three percent, but the real rate is falling as inflation ticks up. If core PCE stays sticky, the Fed can’t afford to ease too quickly, even with GDP growth slowing to one point five percent. Luna: So we’re stuck in this limbo where growth is weak but inflation won’t budge? Lucas: That’s the definition of stagflation-lite. Not full-blown stagflation because unemployment is still low at four point one percent, but close enough to make policymakers sweat. The ten-year breakeven rate is sitting at two point three one percent, which tells me the market doesn’t think inflation will collapse anytime soon. Luna: And yet the S&P is barely moving. Investors seem to be pricing in a soft landing without addressing the wage pressure. Lucas: They’re betting that productivity gains will offset the wage costs. If AI and automation start driving output per worker up faster than wages rise, then companies can absorb the higher labor costs without raising prices. But we haven’t seen that productivity surge yet. Luna: It feels like a gamble. What if the productivity boom takes longer to materialize than everyone expects? Lucas: Then we get a reacceleration of inflation. That’s the risk the Fed is weighing right now. They’re watching initial jobless claims drop to two hundred and three thousand, which means layoffs aren’t happening. No layoffs means no downward pressure on wages. Luna: So the only way out is either a recession that breaks the wage cycle or a massive productivity jump. Neither seems guaranteed. Lucas: Correct. And that uncertainty is why the yield curve is still inverted. Short-term rates stay high while long-term yields climb, reflecting fear of future inflation rather than current growth. Luna: Does this mean the Fed will hold rates through September and maybe even October? Lucas: I think they’ll hold through September. The data needs to show a clear cooling in wages before they touch the lever. And honestly, with euro zone inflation also ticking back above three percent globally, external price pressures aren’t helping either. Luna: Global spillover. Right, everything is connected. So we watch the next CPI print and see if wages finally break. Lucas: Exactly. Until then, expect volatility in bonds and patience from the central bank. It’s a delicate balancing act, and one wrong move could reignite price pressures. Luna: Thanks for supporting Fexingo. We deliberately don't run ads on these shows, and listener contributions help us keep producing daily deep dives like this. If walking through the economy with us has made something click, the link is buy me a coffee dot com slash fexingo. Lucas: Yeah, your support keeps the lights on and the research sharp. We appreciate it. Luna: Back to the data, though — what about the impact of those job openings on small businesses specifically? Lucas: Small businesses are hit hardest by wage hikes because they lack the scale to negotiate better terms with suppliers or pass costs onto customers easily. Many are closing their doors simply because they can’t afford the new payroll reality. Luna: That’s a hidden cost of tight labor markets. Consolidation favors big players who can absorb higher wages. Lucas: Exactly. It accelerates market concentration, which eventually reduces competition and keeps prices high for longer. So the labor shortage might be solving itself by eliminating competitors. Luna: Dark but logical. So we’re watching for both wage data and merger announcements to gauge the next move. Lucas: Precisely. Two signals to track: hourly earnings trends and M&A activity in the service sector. Luna: Makes sense. One final thought — does the Fed care about this consolidation effect, or just the headline inflation number? Lucas: Primarily the headline. Their mandate is price stability, not competition policy. But if consolidation drives prices up structurally, they’ll eventually have to react to the outcome. Luna: So the Fed is playing catch-up to a structural shift they didn’t anticipate. Lucas: Maybe not catch-up, but certainly recalibrating. The old models assumed labor mobility would cap wage growth. That assumption is breaking down. Luna: Interesting. I wonder if remote work policies are partly to blame for reduced labor mobility? Lucas: Could be. If people aren’t relocating for jobs, local labor markets become siloed, and wages diverge wildly by region. That complicates national monetary policy significantly. Luna: A fractured labor market makes one interest rate fit all harder to justify. Lucas: Absolutely. We might need regional flexibility in policy tools, or at least more nuanced communication from the Fed. Luna: Or maybe just more patience as the system adjusts to this new normal. Lucas: Patience is what they’re offering investors right now. Whether the economy agrees remains to be seen. Luna: We’ll keep watching the numbers. Thanks for tuning in to today’s Macro Memo.