No clear bend in the labor cost trend

Summary

The elevated pace of labor cost growth continues to thwart the Fed's efforts to return inflation back to 2% for the long-haul. The Employment Cost Index, the Fed's preferred read on compensation costs, strengthened more than expected in Q1. The 1.2% increase over the quarter puts the most encompassing measure of labor costs rising at a 4.7% annualized clip. While cost pressures are beginning to ease as the jobs market inches back toward a better balance, we fear a significant deterioration in labor market conditions will likely be needed to fully wring out inflation.

Labor costs keep wrangling inflation back to 2% difficult

Slower wage growth has been an uncomfortable but necessary aspect of returning inflation back to the Fed's target and keeping it there. The latest Employment Cost Index (ECI) showed that progress in tamping down the inflationary impulse from the jobs market remains disappointingly slow. Compensation costs rose more than expected in Q1 on top of an upward revision to Q4 growth. The 1.2% increase in Q1 puts it squarely in the 1.1%-1.4% range registered over the past seven quarters, a sign the trend in labor costs has yet to convincingly ease.

The pickup in the Q1 ECI looks at odds with the more timely and widely watched average hourly earnings (AHE) figures in the monthly employment report. Total AHE slowed to a 3.8% annualized rate in Q1, not terribly far off from a pace we think the Fed could live with given the trend rate of productivity growth, and supportive of the central bank's tightening campaign soon coming to an end. But the ECI trumps AHE as far as Fed policy goes. The ECI provides a more encompassing view of labor cost pressures as it includes private and public sector workers as well as the benefit portion of compensation (about 30% of the total). Moreover, the ECI controls for compositional shifts in the workforce. This distinction is particularly key in the current environment when jobs in leisure & hospitality—the lowest paying industry—are growing more than twice as fast as total employment.

Furthermore, the ECI is not alone in suggesting that labor cost pressures are not cooling as much as the headline average hourly earnings number indicates. AHE for production & non-supervisory workers, which account for about 80% of private sector workers, rose at 4.5% clip in Q1 and point to upward pressure on labor costs remaining more acute outside of supervisory roles.

The recalcitrant trend in labor costs was evident by both sector and compensation type. Total private compensation growth was little changed over the quarter, with a third consecutive rise of 1.2% in wages & salaries and 1.1% rise in benefits. Public sector compensation rose on par with Q4 (up 1.1%), as slightly softer growth in wages and salaries was offset by a pickup in benefits.

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