Wage growth, inflation concerns recede . . . for now
For more than a month now, investors have been searching for clarity amid the recent stock market chaos. Between concerns over rising inflation, the year-over-year increase in prices for consumer goods and services, and now President Trump’s proposed steel and aluminum tariffs, the stock market is proving to be the ultimate rollercoaster ride. February’s employment report, released on Friday, March 9, simply added another twist and turn.
With the release of the employment report, the Dow Jones Industrial Average soared, gaining 440 points. But it wasn’t because the economy added a stellar 313,000 jobs in February or that the strength of the U.S. labor market is expected to continue. No, the surge in stock prices was caused by something else – a pullback in wage growth.
Now, why would a decline in wage growth send the Dow soaring 440 points? Don’t employee wages serve as the fuel for consumer spending, which accounts for two-thirds of all economic activity in the U.S.?
The answers lie in wage growth’s impact on inflation. For the past few years, employee wages have grown at a very moderate 2.5 percent year-over-year pace. But January’s employment report, released on February 2, showed wage growth had surged to 2.9 percent, its fastest pace in eight years. This triggered a week-long 8.9 percent 2,326-point decline in the Dow, as concerns a sudden spike in wage growth would send inflation rising faster and higher than previously expected. Consequently, the Federal Reserve might become more aggressive in raising short-term interest rates to help keep this rising inflation in check.
The Fed had planned three 0.25 percent interest rate hikes this year. But if wages were to start rising faster than previously expected, this might lead to a potential fourth rate hike. As interest rate hikes carry risks, the more rate hikes the Fed has to implement, the greater the chance something can go wrong to disrupt the current economic growth.
But in February, annualized wage growth pulled back to just 2.6 percent - slightly above its multi-year average. January’s 2.9 percent growth rate was also revised down to 2.8 percent. For the financial markets, February’s employment report reflects a more moderate pace of wage growth, alleviating some of the concern of inflation rising too fast, along with the potential need for a fourth interest rate hike.
Also providing support to a more gradual pace of inflation was Tuesday’s reporting of the core Consumer Price Index, a key monthly measure of inflation on household goods and services. The core CPI rate, which excludes the more volatile and seasonal food and energy prices, showed prices rising in February at an annual pace of 1.8 percent, the same as the prior two months. The markets had been expecting prices to increase by 1.9 percent.
The next test will come on March 29, with the release of the core Personal Consumption Expenditures Index, the Fed’s preferred measure of inflation. The core PCE inflation rate has held steady at 1.5 percent since December and no change is expected. However, any increase to the core PCE rate could very well rekindle concerns on inflation and potentially send the stock markets into decline. For now, at least, concerns over inflation rising too quickly have been tempered.
Mark M. Grywacheski, Investment Advisor
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Quad Cities Investment Group, LLC is a registered investment advisor with the U.S. Securities Exchange Commission.
