In response to better-than-expected consumer price data for October, equity markets surged last week. The S&P 500 recorded its best week since early summer. Treasury markets were equally euphoric. The yield on the benchmark 10-year Treasury bonds fell to 3.81%, down from 4.17% on Nov. 4.
Still, wage inflation is far from defeated, and the Federal Reserve will continue to raise interest rates aggressively.
HOLIDAY TROUBLE: INFLATION AND RECESSION FEARS DING SEASONAL HIRING
The Federal Reserve Bank of Atlanta said wage inflation was 6.4% in October, up from 6.3% in September. Top line: Inflation remains a big problem. The market reaction to one month’s consumer price index is a head fake, especially considering that the Federal Open Market Committee wants lower equity prices and, for that matter, lower house prices.
Perversely, the reaction of the equity and mortgage markets to the October CPI report increases the probability that the Fed will raise interest rates by 0.75 percentage points on Dec. 14. High equity prices and elevated residential real estate values raise household confidence and encourage consumption. The Fed wants lower consumption in order to dampen demand for labor.
Labor demand remains very robust. The data on weekly jobless claims are clear evidence that there is little slack in labor markets. The weekly jobless claims report for Nov. 10 came in at 225,000, near pre-pandemic levels when labor markets were also very tight. Moreover, the Bureau of Labor Statistics said the labor force participation rate is at 62.2% and that the employment-population ratio is at 60%. Both measures of available labor have shown little net change since early 2022. To illustrate the tightness of labor markets, both measures are 1.2 percentage points below their levels of February 2020, right before COVID-19 spread across the nation.
But most importantly from the standpoint of a tight labor market and rising wage inflation, the economy continues to expand. The Federal Reserve Bank of Atlanta projects real GDP growth of 4% for the fourth quarter.
Given the resilience of the economy and very tight labor markets, it is unlikely that wage inflation will fall without significant increases in both interest rates and also in the unemployment rate. Larry Summers is right. Economic pain, higher unemployment, and elevated interest rates are necessary to defeat inflation.
Equity and fixed-income markets are reacting to a short-term economic head fake. Wage inflation is far from defeated.
