The case of the missing pay hike

Russell Price, Senior Economist, Ameriprise Financial

October 2017

Key Points

  • Notably absent in the long economic recovery has been a steady rebound in wages
  • Typically, when unemployment is low, wages rise more quickly, but that hasn’t happened lately
  • There are reasons to expect that compensation trends for employees will improve

One of the mysteries of the current economic expansion is the lack of wage growth, even as the availability of qualified labor has become increasingly tight. 

Stagnant wage growth is not something we like to see in our own paychecks, nor is it good for the broader economy. Consumer spending accounts for nearly 70% of U.S. economic activity, according to the Commerce Department. Wages and salaries represent 58% of personal income for Americans. Much of the rest comes from investment income and other sources. Without growing incomes, consumers will find it difficult to maintain spending levels and the economy would eventually languish.

A historical anomaly

It is reasonable to expect that when the labor market is strong, wages will rise more quickly. This hasn’t occurred in this recovery. Consider that in the month of August, the U.S. unemployment rate was close to a 16-year low of just 4.4%, but average hourly wages were just 2.5% above year-ago levels, according to the Labor Department. This was the same pace of wage growth as when the unemployment rate was 6.0% in mid-2014. Wage growth in that period was just 1% above the current rate of inflation. Historically, Labor Department data shows that wage growth has averaged approximately 4% per year when the unemployment rate is below 5%.

The case of the missing pay hike

The case of the missing pay hike

Data doesn’t tell the whole story

There are a number of theories as to why wage growth has remained so weak, each likely playing some role. 

One suggestion is fairly straight forward – the labor market may not be as strong as it seems. Some unemployment data published by the Labor Department suggests there is more slack in the job market than the headlines imply. 

Older workers, who tend to be at the upper end of the wage scale, have also been retiring at an accelerated pace over the last few years. That puts downward pressure on average wages. Baby-boomers began to reach age 65 in 2011, and a strong stock market has enticed many older boomers who may have delayed their retirement during the financial downturn to belatedly make the transition.

These factors are likely to fade with time, but another influence may subside sooner.

The impact of foreign labor

It’s no secret that foreign competition has depressed income growth for many years. Foreign labor was made cheaper over the last few years by a rally in the value of the U.S. dollar against other major currencies.

A strong dollar makes foreign labor cheaper for American businesses. 

Recently, however, the tide has turned. One trend is that currency markets have reversed, and the dollar has weakened in 2017. It takes time for such influences to alter business decisions, but further dollar weakness could spark faster domestic wage growth. 

Low inflation may be beneficial

In the meantime, modest wage growth should keep inflation in check as it helps businesses avoid raising prices due to higher costs. Contained inflation also reduces the likelihood that the Federal Reserve will need to raise interest rates – a development stock markets would view favorably. In fact, the lack of an inflation threat has, in our opinion, reduced the odds of a third Federal Reserve interest rate hike later this year, although market expectations for a hike remain high.  

Look for wage improvement

We still believe wage and salary growth will gain traction in the months to come. At no other time in the last 40 years has the unemployment rate been this low yet wage growth this weak.

Additionally, there is plenty of ancillary evidence to suggest rising wage offers will occur in the marketplace as businesses struggle to find the qualified workers they need.

Still, this is an important issue for investors. Weak wage growth could weigh on the pace of economic growth should it continue. That, in turn, could depress corporate profit growth, particularly in consumer-facing industries. As always, a well-diversified portfolio can mitigate some of these risks. Be sure to talk with your advisor about how your investment mix is positioned today.    

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