Latest / The Federal Reserve Podcast with Fexingo: Interest Rates, FOMC Meetings, and Monetary Policy / Why the Fed Is Watching the Wage-Price Spiral Signal
Transcript
- Lucas: So the July jobs report came out on Friday, and the headline number was ugly. The economy lost twenty-three thousand jobs. But the number that has the Federal Reserve's attention isn't the payroll count. It's the wage figure. Luna: Right, because if wages are still climbing, that feeds straight into the Fed's biggest fear. A wage-price spiral. Lucas: Exactly. And look, we get a lot of questions about why the Fed seems to fixate on certain data points. So today, let's unpack why average hourly earnings matter more than the job losses right now. Lucas: And before we dive deeper, a quick note. If walking through the economy with us has made something click for you, a couple of dollars a month is genuinely what keeps these going. You can support the show at buy me a coffee dot com slash fexingo. It makes a real difference, and we appreciate every bit. Luna: Yeah, it really does. And we're back to wages. So the July report showed average hourly earnings up... what was it, zero point three percent month over month? Lucas: Zero point three percent, which on an annualized basis is around three point six percent. And that's the number the Fed is chewing on, because it's still above what they consider consistent with their two percent inflation target. Luna: So even though the economy lost jobs, the fact that wages are still growing at that pace is a red flag for the Fed. Lucas: Exactly. And it's a tricky signal because you have two competing narratives. On one hand, the labor market is clearly cooling. Twenty-three thousand jobs lost in July, and the unemployment rate ticked up. But on the other hand, wage growth isn't slowing as fast as the Fed would like. Luna: That's the conundrum. How do you have job losses and still see wage pressure? Usually those don't go together. Lucas: It's a lagging indicator. Wages are stickier than employment. Companies are reluctant to cut pay even when they're trimming headcount, especially for the workers they keep. So you can get this weird period where the labor market is softening but wage growth remains elevated. Luna: And that's exactly what the Fed is worried about, because if wages keep rising, that feeds into services inflation. Think haircuts, restaurant meals, healthcare. Lucas: Right. And we saw in the latest PCE data that core inflation ticked up. Core PCE went from one hundred thirty point zero nine to one hundred thirty point three. Small move, but it's the wrong direction. Luna: Meanwhile, headline CPI actually fell. So you've got this divergence where the Fed's preferred measure is showing inflation is still sticky, and wages are a big reason why. Lucas: And that's why the Fed isn't rushing to cut rates. The market has been pricing in a cut this year, but the Fed is looking at this wage data and thinking, we can't ease policy if the wage-price spiral is still a risk. Luna: But isn't there an argument that the job losses are the leading indicator, and wages will follow? I mean, if unemployment keeps rising, wage growth should cool off eventually. Lucas: That's the hope. And historically, wage growth does lag the labor market. But the Fed has been burned before. In the seventies, they eased too early, and inflation re-accelerated. They don't want to repeat that mistake. Luna: So they're willing to tolerate a weaker labor market to make sure inflation is truly dead. Lucas: At least for now. And the recent commentary from Fed officials suggests they're more concerned about upside inflation risks than downside growth risks. The July jobs report may not change that calculus much. Luna: But what about the two-year yield? It's been falling. Doesn't that signal the market expects a cut soon? Lucas: It does, and that's interesting because the two-year yield is the most sensitive to Fed policy expectations. It fell to around three point seven one percent, which is down from a few weeks ago. The market is clearly betting on a cut. Luna: So there's a disconnect between what the market expects and what the Fed is signaling. Lucas: Exactly. And that's a recurring theme this year. The market keeps pricing in cuts, and the Fed keeps pushing back. Part of it is that the Fed wants to keep financial conditions tight enough to dampen inflation, and part of it is genuine uncertainty about the data. Luna: And this is where the wage data becomes the tiebreaker. If wage growth decelerates to, say, three percent or below, that gives the Fed cover to cut. But as long as it's hovering around three point six percent, they can't. Lucas: Right. And it's not just the overall number. The Fed looks at wage growth by sector. Services wages, for example, are more directly linked to inflation than goods wages. Luna: So what should listeners watch in the next few months? What's the one number that will tell us if the Fed is ready to move? Lucas: I'd say watch the monthly wage print, especially the three-month annualized rate. If that drops below three percent, you'll likely see the Fed start to signal a cut. If it stays above three point five, they'll hold firm. Luna: And of course, the next jobs report and the August CPI will be big. But it's the wages that will really tip the scales. Lucas: Exactly. And we should also mention that the Fed is watching breakeven inflation rates. The ten-year breakeven is around two point two five percent, which is actually down slightly. That suggests the market isn't too worried about long-term inflation, but the Fed is more focused on the near-term path. Luna: So the market is saying inflation will be under control, but the Fed is saying, not so fast. Lucas: Right. And that's the delicate balance they're trying to strike. They want to avoid overtightening and causing a recession, but they also don't want to ease prematurely and let inflation re-ignite. Luna: It's a tough spot. Especially with the labor market showing mixed signals like this. Lucas: It is. And honestly, the Fed is going to be data-dependent for the foreseeable future. Every jobs report, every CPI print, every PCE update will be scrutinized. But the wage component is the one I'd keep an eye on. Luna: Because if wages start to cool, that's the green light for a cut. And if they don't, we're in for a longer hold. Lucas: Exactly. And that's the takeaway for today. The July jobs report was disappointing, but the Fed is looking past the headline and focusing on what it means for inflation. And right now, the wage signal is keeping them cautious. Luna: It's a good reminder that the Fed's job isn't just to react to the latest data point, but to look at the bigger picture. Lucas: And the bigger picture is still uncertain. So we'll keep watching, and we'll keep you informed. Thanks for listening, and we'll catch you next time.