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September 2023 | Issue 257

Fed members need to restore their credibility, which could translate into excessive tightening

Duncan Sankey
Portfolio director and head of credit research Cheyne Capital
quotation mark
Rising wages have boosted spending and GDP — but the party can’t last forever
Not so long ago, I made a breezy prediction that we should not worry about labour cost inflation. Private sector unionisation in the US had fallen to around 6% just before the pandemic, from around 25% in 1970 (with a similar trend in other liberal market economies). This, coupled with a raft of anti-union legislation, would keep labour emasculated. Was I ever wrong? Today, rising wages are the single biggest factor underpinning stubbornly high core inflation, which is, in turn, fuelling a higher-for-longer rates policy. At the risk of being topped and tailed, I think there is a cogent case for believing that wage inflation will prove intractable and may lead to an over-zealous policy response.
Before I choke on the humble pie, I stand by my assertion that labour is fragmented and disorganised. And yet workers have acquired a new militancy. A recent article suggested as many as 600,000 US union members, from airline pilots to teamsters, were contemplating strike action.
Over-55s turn away from work
An understanding of the new-found activism begs an understanding of structural changes in the labour market. The percentage of the available US labour force aged 55 and over has increased from about 1 in 8 at the turn of the millennium to 1 in 4 currently (in the EU from about 1 in 10 in 2004 to 1 in 5 by 2019). Over-55s’ participation in the labour force increased with their share of the population from 1995-2010, but then flatlined. During the pandemic, it declined sharply and never recovered. Thus, a portion of the fastest-growing part of the population, and the most experienced part of the labour force, has absented itself just as demand is normalising post-pandemic.
There is no simple explanation. Some workers have called in sick. In higher income brackets, some have called in rich. According to the University of Michigan Consumer Survey, the percentage of over-55s reporting primary residence values and stock market investments both over $500,000 rose from 5% and 11%, respectively, in June 2002 to 32% and 35% in June 2022. If their parents were the Greatest Generation, they are the generation with the greatest pensions — often liberal defined benefit schemes. It is not surprising that some should have called it quits after covid.
The enhanced bargaining power conferred on those still in work is clearly manifesting in wage inflation: the latest reading for the Atlanta Fed wage tracker points to a 6% increase in the 12-month moving average of median wages — 7% for those willing to switch jobs. The percentage of US workers voluntarily separating from their employer has fallen from its post-pandemic peak, but remains higher than any level from 2000-2020.
Higher wages create a virtuous circle
To date, the impact on profit margins has been mixed. Companies in concentrated industries (for example, tyre manufacturers) or those with capacity constraints (auto manufacturers, airlines) have enjoyed significant pricing power and have, in some cases, boosted profitability and cash generation. Higher wages have also created a virtuous circle in terms of consumer spending, with outlays on goods and services helping to support GDP growth. But the party cannot go on indefinitely. 6% wage growth is inconsistent with central bankers’ 2% core inflation objective.
We have a long way to go. The US unemployment rate is at its lowest since the late 1960s and there are about 1.6 vacancies for each unemployed person; eurozone unemployment is at a record low. Nor are there simple fixes on the supply side. We are seeing growing investment in automation and technology, but it will not effect immediate change. Migration-based solutions are politically radioactive, while reproduction rates show no signs of increasing and, in any case, would take generations to feed through.
This leads us back to demand-side management and monetary policy. In the minutes from the last Fed meeting in July, participants noted the need for softening in the labour market and “a period of below-trend growth in real GDP”.
Unfortunately, economies, being composed of people, do not lend themselves to fine-tuning and the track record on soft landings is not compelling. Fed members called inflation wrong on upside and need to restore their credibility, which could translate into excessive tightening and a sharper-than-expected downturn in 2024.
Let’s hope I’m wrong. Again.
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Global credit funds & CLO's
September 2023 | Issue 257
Published in London & New York.
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