Will wages work on the Fed?

Posted by: Paul Donovan

15 Feb 2019
  • The US Federal Reserve is likely to raise interest rates when inflation is over 2%. (Growth would also need to be over 2%. Markets should also expect a rate rise).
  • Wage growth is an inflation pressure. The US labor market is very strong. Wage growth is 3.5% to 4.0% today. Companies are not just having to pay more to attract new staff. Companies are having to pay more to stop existing staff from leaving. In any major economy, domestic labor costs are over two thirds of company costs, so this matters.
  • However, higher costs do not always mean higher inflation. Companies may cut their profit margins if they are not confident they can pass costs on to customers. The US profit share of the economy is at a very high level and could easily come down. UBS expects global equity earnings growth to be slower than global economic growth in 2019, which suggests profits may grow more slowly than the economy.
  • US inflation today is normal - in line with its long-term average. At some point, price increases should allow the Fed to raise US rates. But investors might want to consider if labor cost inflation will hit profits too.

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