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Larry’s note: Welcome to Trading with Larry Benedict, the brand new free daily eletter, designed and written to help you make sense of today’s markets. I’m glad you can join us. My name is Larry Benedict. I’ve been trading the markets for over 30 years. I got my start in 1984, working in the Chicago Board Options Exchange. From there, I moved on to manage my own $800 million hedge fund, where I had 20 profitable years in a row. But these days, rather than just trading for billionaires, I spend a large part of my time helping regular investors make money from the markets. My goal with these essays is to give you insight on the most interesting areas of the market for traders right now. Let’s get right into it… |
It’s fair to say that there were no surprises with either of the Fed’s announcements on Wednesday…
First, that it would leave interest rates unchanged. Second, that it would begin tapering asset purchases (bond buying) as soon as this month.
After all, when it comes to tapering, the Federal Reserve has been planning a move like this for months. It plans on ending the bond buying program by June 2022.
Unless inflation rates continue to rise, the Fed will not raise rates before the bond buying program ends.
Meaning, right now, there’s little to no chance of a rate rise by next summer.
When it comes to inflation, most of us think in terms of its effect on prices like the cost of groceries or filling up a tank of gas.
However, today I want to talk about some of its wider implications. Specifically, how inflation flows into jobs and wages.
The relationship between wage growth and inflation
When it comes to a weekly paycheck, many folks only focus on how much they earn after taking out taxes (and any other outgoings).
However, what that paycheck fails to tell you is what you’re really earning.
Looking at your income without considering inflation only captures half of the picture.
When inflation is low – like it has been for over a decade (until recently) – it’s less of an issue.
But, with inflation now running regularly at over 5%, it’s has much more of an impact on real wages.
Quite simply, if people’s pay doesn’t keep up (or surpass) with inflation, then they’re going to keep slipping further behind. They’ll have less to spend, and that’s bad for the economy.
That’s why Fed Chairman Jerome Powell referred to the Employment Cost Index data from last Friday in his statements on Wednesday.
For the most recent quarter (Q3), employment compensation costs rose 1.3% over the previous quarter. That was 0.4% above market expectations.
Annualize that out to around 5.2%, and it’s roughly around the current rate of inflation.
Meaning that even if wages are currently improving, wage earners are still barely making ends meet.
For their standard of living to really improve, then wage growth needs to exceed inflation.
You can see how difficult it is to try to manage this balancing act between wages and inflation.
While the Fed can try to rein in inflation by increasing interest rates, wages are essentially out of their control because they’re driven by the market.
Which means that supply and demand ultimately determine wages and wage growth.
And, with employment conditions tight at the moment, that means that employers need to offer higher wages to attract new staff to join (or retain existing ones).
And that’s where wage growth can cause a problem with inflation…
If those wages rise without an accompanying increase in productivity, then eventually businesses will be left with two choices…
First, they will have to accept lower margins (from higher wage costs) and therefore lower profits. Or second, they will instead pass those increased costs onto consumers, which in turn keeps pushing up inflation.
You can see how it could become a circular problem.
The 1.3% rise in compensation costs last quarter put wage growth right in the spotlight. You can be sure the Fed (and the markets) will be watching this closely over the coming months.
And, of course, the other thing they’ll be watching is inflation.
Last month’s data showed inflation already running at 13-year highs. And with key inflation data due out next Thursday (November 11), any spike higher would likely spook the market.
Regards,
Larry Benedict
Editor, Trading With Larry Benedict
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