Latest / The Macro Memo with Fexingo: Daily Conversations on Inflation, GDP, and Federal Reserve Policy / The Sticky Wage Inflation Trap
Transcript
- Lucas: Look at the headline number from the Bureau of Labor Statistics for August. The CPI came in at three hundred thirty-four point one, which sounds precise until you realize it’s barely moving off the plateau we’ve been stuck on all summer. But here’s the thing that keeps me up at night, not the headline print itself, but the wage side of that ledger. Luna: You mean the fact that workers are finally seeing raises, but businesses are just passing those costs straight through to consumers without adding any efficiency? Lucas: Exactly. Average hourly earnings for private industries hit thirty-seven dollars and eighty cents. That is a solid increase year-over-year, but when you look at real GDP growth sitting at a sluggish one point five percent annualized, there’s a glaring disconnect. We aren’t producing enough extra value to justify those wage hikes without raising prices, and that is the definition of a wage-price spiral waiting to happen. Luna: So the labor market isn't cooling; it's just getting expensive for employers, who are then pricing that expense into every service transaction. Lucas: Right. And the Federal Reserve is watching this with extreme caution because their favorite gauge, the Core PCE price index, is still hovering around one hundred thirty point seven. That implies inflation is running closer to two point five percent than the two percent target they promised us. If wages keep climbing while productivity stays flat, the Fed has no choice but to hold rates steady or even hike again, which would be brutal given we are already at three point six three percent on the federal funds rate. Luna: It feels like we're trapped in a middle ground where neither consumers nor companies can breathe, yet the central bank refuses to blink first. Lucas: That’s the trap. Let’s drill into the services sector specifically, because that is where the heat is concentrated. Goods inflation has largely cooled thanks to global supply chain normalization, but services—healthcare, housing, professional fees—are entirely domestic. They rely on people, and people want more money. The JOLTS report showed job openings actually ticked up to seven thousand two hundred seventy-one thousand last month. That signals employers are still desperate for bodies, which gives them zero leverage to suppress wages. Luna: Desperate employers mean bidding wars for talent, which means higher costs for the end user. It’s a simple chain reaction that everyone seems to be ignoring. Lucas: They’re ignoring it because acknowledging it admits their previous policy mistakes. For years, the narrative was that inflation was a temporary glitch caused by pandemic supply shocks. Now, with the ten-year breakeven inflation rate dropping slightly to two point three six percent, markets think we’re safe. But if you look at the underlying structure, the labor force participation rate hasn’t recovered to pre-pandemic trends, meaning the pool of available workers is structurally smaller. Fewer workers chasing the same amount of economic activity drives wages up, period. Luna: So it’s not just about demand pulling prices up; it’s a supply constraint that’s baked into the demographic reality now. Lucas: Precisely. And this brings us to the donation segment. If walking through the economy with us has made something click, the way these stay ad-free is listener support — buy me a coffee dot com slash fexingo. It helps us keep digging into the data so you don’t have to guess what’s happening with your money. Luna: Yeah, and honestly, if you find our breakdowns of complex metrics like the PCE deflator useful, that support directly fuels the research behind every single episode. Lucas: Thanks for listening. Back to the macro picture. The problem with this wage dynamic is that it creates a false sense of security for consumers. Sure, your paycheck might be growing, but if the cost of living is rising faster than your purchasing power, you’re effectively poorer. That’s why consumer outlook plunged in September according to recent surveys. People feel the squeeze even if their bank account balance looks okay on paper. Luna: It’s the erosion of real wages that matters most. When prices rise faster than income, discretionary spending vanishes, which should theoretically cool inflation, right? Lucas: Theoretically, yes. But historically, we see a lag. Businesses don’t cut prices immediately when demand drops; they absorb margins first. And right now, corporate margins are still surprisingly resilient. We’re seeing companies in retail and hospitality holding firm on prices because they know consumers have nowhere else to go. It’s an oligopolistic situation where a few big players set the standard, and if one raises prices due to wage costs, everyone follows suit to protect their bottom line. Luna: So we’re looking at structural pricing power rather than competitive pressure. That makes the inflation much stickier than models predicted. Lucas: That’s why the Fed’s split from the markets this season is so telling. The S&P 500 is flirting with seven thousand six hundred fifty-seven, and the Nasdaq is near twenty-six thousand three hundred thirty-three, but those indices are forward-looking. They assume the soft landing will work. The Fed is backward-looking. They see the actual data points from August, and they see a labor market that is too hot for comfort. They can’t afford to pivot to rate cuts until they see wages slowing down relative to productivity. Luna: Which isn’t happening. Productivity is stagnant, wages are rising. The math doesn’t add up unless prices go up. Lucas: Correct. And let’s talk about the bond market for a second, because it’s starting to wake up. The ten-year Treasury yield jumped to four point nine seven percent recently. That is a significant move. Investors are realizing that the era of cheap money isn’t coming back anytime soon. If the Fed holds rates higher for longer to crush that wage-driven inflation, long-term borrowing costs will stay elevated, which hits commercial real estate and small business investment hard. Luna: High yields kill valuations. So we might see a correction in asset prices before the inflation problem is fully solved. Lucas: Likely. And this is where the distinction between nominal and real GDP becomes critical. Nominal GDP is tracking well above thirty-two trillion dollars, driven partly by inflation itself. But real GDP, adjusted for price changes, is only growing at one point five percent. This divergence tells us that a large chunk of that economic 'growth' is just nominal noise. We’re spending more money to get less stuff. That’s inefficient and unsustainable. Luna: It’s growth in name only. And it masks the underlying weakness in the real economy. How does the Fed react to that inefficiency? Lucas: They try to engineer a slowdown. By keeping the federal funds rate at three point six three percent, they’re trying to dampen demand enough that employers stop needing to raise wages aggressively. But if the labor shortage persists, employers will just borrow more to pay those wages, keeping the cycle alive. It’s a vicious loop. Luna: Unless there’s a shock. A sudden drop in job openings or a spike in unemployment claims could break the momentum quickly. Lucas: That’s the wildcard. Initial jobless claims are down to two hundred six thousand, which is very low. That suggests the labor market is incredibly tight. But if that number starts ticking up, even slightly, it could signal that the tightening is finally working. However, the Fed is terrified of causing a recession. They want a gentle landing, but with sticky inflation, the road to a gentle landing is littered with potholes. Luna: So they’re walking a tightrope. Too tight, and they crash the economy. Too loose, and inflation remains entrenched. Lucas: Exactly. And the public is losing patience. When consumers see their grocery bills and insurance premiums rising despite their raises, trust in institutions erodes. That political pressure can force the Fed’s hand in ways that pure economics wouldn’t predict. We’ve seen central banks get fired or pressured before when inflation runs wild. Luna: It adds a layer of risk that isn’t captured in the spreadsheets. Politics always intersects with monetary policy eventually. Lucas: Always. And right now, the intersection is messy. With the VIX hovering and market volatility picking up, investors are pricing in the possibility of a policy error. Either the Fed waits too long and causes a downturn, or they ease too early and reignite inflation. Both outcomes are painful. Luna: And ordinary people are caught in the crossfire, trying to plan their finances with no clear direction from the top. Lucas: That’s the reality. We’re in a period of high uncertainty where the old rules of economics seem to have been rewritten by labor dynamics and geopolitical shifts. The key metric to watch next isn’t just CPI, but the wage growth component within it. If average hourly earnings start to decelerate while productivity picks up, then we have hope. If not, we’re staring down another year of persistent inflation. Luna: So we wait and watch the payroll reports, hoping for a sign that the labor market is finally normalizing rather than just inflating. Lucas: Exactly. Until then, the Fed sits on its hands, and the rest of us adjust our budgets accordingly. It’s a slow burn, but the stakes are incredibly high for everyone involved. Luna: Here’s hoping the data turns in our favor before the winter holidays. Lucas: One can only hope. Thanks for tuning in to The Macro Memo.