The Big Idea
Wage gains remain substantial
Stephen Stanley | March 3, 2023
This document is intended for institutional investors and is not subject to all of the independence and disclosure standards applicable to debt research reports prepared for retail investors.
Much has been made in recent months of the deceleration in wage gains as measured by average hourly earnings. A recent news article went so far as to suggest that we could see a “reverse wage price spiral,” with cooling wages pushing inflation back down to 2% over time. Unfortunately, this notion may be wishful thinking, at least for now, as underlying wage growth likely has not moderated by as much as the average hourly earnings figures suggest. And the labor market is still too tight to warrant a quick deceleration in pay.
Average hourly earnings
Average hourly earnings garner by far the most attention from financial markets of the various wage measures. This likely owes mainly to their monthly reporting cycle, making the numbers more timely than the Employment Cost Index, or ECI, for example. They also come in a prominent economic release, the monthly employment report.
In any case, average hourly earnings have decelerated noticeably since peaking on a year-over-year basis in early 2022. Average hourly earnings for all workers peaked near 6% in early 2022 and moved down to 4.4% as of January 2023 (Exhibit 1).
Exhibit 1: Year-over-year growth in average hourly earnings
The main problem with the average hourly earnings series is that it measures the average wage of everyone that happens to be included in the payroll count in a given month. It consequently can be skewed by changes in the composition of the workforce. During the Covid lockdowns, a disproportionate fraction of the layoffs that occurred were in low-wage jobs such as retail and restaurants, which led to a spike in average hourly earnings. As those workers gradually returned, the upward distortion in average wages receded over time. This can be seen in the upward spike in 12-month wage gains in 2020 and the mirror-image drop in 2021, when the elevated 2020 readings fell out of the 12-month window.
More recently, lower-wage positions appear to be dominating the growth in payrolls, as sectors that are still recovering from pandemic-era layoffs, like restaurants, day care centers, and personal services, tend to have below-average pay rates. So at least a portion of the 150 bp deceleration in nominal 12-month pay increases over the past 10 months likely reflects compositional changes rather than cooling wage inflation.
Alternative wage measures
There are two other pay measures less prone to the compositional biases that plague average hourly earnings. First, the ECI is a quarterly series also compiled by the BLS. For this gauge, the BLS goes to significant lengths to create a consistent basket of job titles and responsibilities from one quarter to the next in an effort to avoid composition bias. BLS surveyors detail the skills and knowledge required for each job title sampled in an effort to create a consistent basket of jobs from one quarter to the next, ensuring comparability over time.
The Atlanta Fed Wage Tracker takes a more straightforward approach to achieving consistency. This gauge takes the wage data collected in the BLS Household Survey and records the 12-month change for the specific individuals who were included in the surveys for both dates and then reports the data on a 3-month average basis. The series has a much smaller sample size than the average hourly earnings figures—about 9,300 a month—but it represents a true apples-to-apples comparison, year-over-year changes for the wages of the same individual.
It is useful to compare the wage and salary component of the ECI and Atlanta Fed Wage Tracker to the broad average hourly earnings gauge (Exhibit 2). The ECI never accelerated to as high a pace as the other two measures but has yet to decelerate noticeably at all, remaining just above 5% at the end of 2022. Meanwhile, the Atlanta Fed Wage Tracker peaked last summer at 6.7% and has come off to 6.1% as of January, less than half of the moderation recorded by the average hourly earnings series.
Exhibit 2: Year-over-year growth in wage measures
In particular, note that when average hourly earnings peaked on a year-over-year basis at around 6% in early 2022, the series was roughly in line with Atlanta Fed gauge. However, since then, while the average hourly earnings figures have steadily cooled, the Atlanta Fed Wage Tracker ascended further before coming off its peak and now sits at roughly the same level (about 6%) as in early 2022.
The ECI and Atlanta Fed Wage Tracker in my view offer a cleaner read of the true underlying trends in wage gains. They both suggest that while pay hikes may have come off of their highs, they have yet to decelerate substantially.
Setting aside the pros and cons of the various measures, the story traced out by the ECI and Atlanta Fed gauge strike me as more consistent with the evolution of the labor market over the past year than the trajectory of average hourly earnings. The extreme labor shortage of 2021 and 2022 that led to a feeding frenzy of poaching by employers and undoubtedly inflated wage hikes has perhaps abated somewhat, but there were still nearly two job openings for every unemployed person as of December, and the unemployment rate in January matched the lowest in 70 years. Thus it seems like wishful thinking to believe that wage pressures have dissipated meaningfully. Until the labor market cools more definitively, pay hikes are likely to remain elevated, far too high to be consistent with the Fed’s 2% price inflation target.