What's up with wages?

Quick read:

• Robust labor demand, low participation rates, and accelerating wages across the US, Europe, and Japan have raised the question: Will wage growth return to levels consistent with central banks’ inflation targets, or remain sticky at higher levels?
• To answer this, we need to disentangle post-COVID restart effects from a potential structural change in wage dynamics. A detailed analysis of US household microdata helps to inform our view that wage growth has broadened across industries, is elevated across both job changers and job stayers, and appears set to settle structurally higher than in the previous decade.
• In our view, structurally higher wage growth likely makes economies more resilient to higher levels of interest rates. In contrast to the “New Normal” post-Global Financial Crisis paradigm of more sluggish growth and inflation, we believe we are entering a period of “Old Normal” more akin to the macro environment of higher growth and higher interest rates that preceded the Global Financial Crisis. In our tactical multi-asset portfolios, we have reflected this with short duration exposures and by favoring value over more rate-sensitive growth areas of equities.

Jay, we have a problem

The Federal Reserve knows that it has a wage growth problem. Jay Powell recently described a situation where “demand for workers far exceeds the supply of available workers, and nominal wages have been growing at a pace well above what would be consistent with 2% inflation over time [emphasis added].”¹ Despite rapid monetary tightening in 2022, labor markets have continued to prove resilient and January’s employment and personal income data indicated no signs of a slowdown.

The US labor market of the past two years has, by many measures, been the tightest since World War II. In addition to a historically low unemployment rate, demand for workers has been exceptionally strong. A helpful way to visualize labor market demand is openings per worker (i.e., number of job openings divided by the total size of the US labor force). As shown below, we currently observe remarkably elevated demand for workers in the US.

Demand for US workers is historically high

A new regime for wages?

To better understand the outlook for wages, we analyze the household microdata that underpin the labor market statistics. The Current Population Survey (CPS) is a timely and comprehensive survey of US households.³ For this application, it allows us to compute year-over-year wage inflation at the household level while also controlling for the industry of employment and whether the employee changed jobs.

The latest reading for economy-wide wage growth point to 6.6% year-over-year gains. More important than the exact level of current wage growth, however, are the time series and industry-level dynamics, which are shown below.

Our first observation is that the initial burst of wage inflation that happened in some of the most COVID-impacted industries, like Leisure & Hospitality. Employers had to pay up to lure workers back, which led to a fast and sharp acceleration in wages. This was a one-off effect on the way up, and we are currently experiencing a corresponding one-off deceleration. While these restart effects explain much of the recent softening in wage inflation, we believe this effect is unlikely to persist for much longer.

Wage growth is higher across all industries

Should I stay or should I go?

In addition to understanding the cross-industry dynamics of wages, we also analyze wages for job switchers compared with job stayers. Based on the CPS data, approximately one-third of individuals who experienced a wage change are associated with a change in role or firm (switchers), which we view as distinct from wage changes for individuals in the same role (stayers). Over the last year the share of both switchers and stayers with year-over-year wage gains have jumped, but it is only by digging into the industry-level dynamics that we can gain a more detailed understanding.

In the plots below, we compare the average wage gains at the industry level across these two types of individuals. Focusing on Education & Health and Leisure & Hospitality highlights how job switchers typically lift all boats; individuals typically change roles to receive higher pay. However, the level of wage growth amongst job stayers is also currently materially higher across all industries compared with pre-2020 levels. This is likely the more important series to watch going forward since the elevated wage growth amongst job stayers boosts overall income growth across throughout the US economy.

Both job switchers and job stayers have experienced wage increases

What do these views mean for portfolio positioning?

Our insights on wage dynamics and the US labor market lead us to position portfolios for structurally higher government bond yields which will be needed to combat persistent and widespread inflation pressures. We remain short duration in developed markets and have shifted our equity exposures to favor value over more rate-sensitive growth areas.