Employment costs in the second quarter registered their smallest increase in a generation bringing into question the linkage between job creation, declining unemployment and wage inflation.
The 0.2 percent rise in the employment cost index followed a 0.7 percent rise in the first quarter and, in 2014, the highest annual increase since the financial crash, according to the Labor Department. Analysts polled by Reuters had forecast a 0.6 percent gain.
Wages and salaries, that is the employment cost index minus benefits, also rose 0.2 percent in the second quarter, the slowest pace since both series began 1982.
Federal Reserve officials have repeatedly said that they expect inflation to gradually move toward the bank’s 2 percent goal and that an improving labor market will bring the gains in wages and salaries that are needed for the economy to return to normal.
Fed Chair Janet Yellen has stated that as long as the bank is confident that inflation is headed toward the target rate over the medium term, a lack of current inflation will not preclude a rate increase. The Fed's own economic projections foresee a core inflation rate of 1.3 to 1.4 percent this year, 1.5 to 1.9 percent next year and 1.8 to 2.0 percent in 2017.
Ms Yellen has voiced her expectation that the first Fed Funds increase since 2006 will be later this year. The Fed Funds rate has been at 0.25 percent since December 2008.
The problem for the Fed is that although by traditional standards the labor market is strong and has already recovered from effects of the financial crash and recession, wage gains have been negligible.
The unemployment rate has fallen from 10 percent in October 2009 to 5.3 percent last month, not far from where most economists consider the work force to be fully employed.
However, the largest reason for the rapid fall in the unemployment rate has been the withdrawal of people from the work force. The labor force participation rate in June was 62.6 percent, representing the lowest percentage of people working since 1977, before women joined the workforce in large numbers.
Non-farm payrolls have averaged 225,000 new positions each month since the beginning of 2013 and 245,000 since the start of last year, both figures are the best in over 15 years.
The monthly average of first time unemployment claims has been below 300,000, a historical indicator of strong employment markets, for the better part of a year and continually since March.
Yet despite these standard signposts of a tight employment economy that would normally cause employers to compete for new workers by increasing compensation, most measures of wages and salaries have been largely stagnant in the past two years, rising little more than the rate of inflation and far less than in the years before 2008.
The annual employment cost index in June was 2 percent higher, down from 2.6 percent in May. Since the beginning of 2013 the average annual increase has been just 2.05 percent. For comparison in the half decade from 2003 to 2007 the ECI rose at an average of 3.45 percent a year.
Average hourly earning exhibit a similar pattern as does personal income.
The annual increase in hourly earnings over the same 30 month period beginning in January 2013 has been 2.1 percent. In 2007 and 2008, the average increase was 3.3 percent.
Personal income grew at a 3.3 percent average rate over the same period, but from 2003 to 2007 the annual expansion in income was 5.6 percent.
In the meantime, inflation, even at its current historically low rate has eaten up close to half the wage and income gains. This has left little extra disposable income to support an increase in consumer spending that might boost the economy beyond its 2.1 percent post-recession GDP trend.
The Fed’s chosen measure of inflation, the core personal consumption expenditure index has averaged 1.5 percent since January 2013. The overall index has measured 1.1 percent. The difference between the two was largely driven by the precipitous fallen energy prices since last summer.
Until the U.S economy can draw the millions of workers who have abandoned the labor economy back into the market, their presence is likely to remain a drag on wage increases and an impediment to the Fed's expectation that rising wages will, finally, power a robust economic recovery.
Chief Market Strategist
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