Wage growth trend might not be as poor as new data suggest

Big retail chains are bidding for workers by promising hourly pay well above the legal minimum wage. The number of new unemployment claims two weeks ago fell to a 42-year low. Technology companies are desperate for skilled workers and are posting big recruitment bounties for new engineers.

So how to explain that last quarter saw the most anemic increase in wages and salaries in the 33-year history of the employment cost index – just as economists were growing certain that incomes were finally poised to grow smartly?

On the surface, it appears to be yet another deflating turn in a long but lethargic economic recovery. The ECI – a broad measure of cash compensation and employer-paid benefits – inched higher by only 0.2%, below the 0.6% economists’ had forecasts and a sharp slowdown from the first quarter’s 0.7% gain. 

Traders reflexively cut back on their bond-market bets that the Federal Reserve might begin raising short-term interest rates from bear zero at its September meeting. Fed Chair Janet Yellen has often cited wage gains as a key criterion that will help determine whether the economy is ready for the removal of extraordinary stimulus in the form of zero interest rates. 

Still, there were enough contradictory signals within the ECI release to argue against jumping to the conclusion that worker income growth is truly faltering, or that the Fed will surely wait past September to act. 

For one thing, wage gains in several broad, lower-skilled job categories remained brisk – a welcome sign of labor-market tightness among rank-and-file workers who had suffered disproportionately since the 2008-09 recession. 

Second-quarter employment costs in goods-producing industries rose 0.7%, as did those in the leisure and hospitality fields. Nursing saw a 0.8% increase, and retail jobs had an impressive 1.2% pickup in wages and benefits. 

The source of weakness came in white-collar areas, such as technical and professional workers and salespeople. This is a bit counter-intuitive, given that Americans in fields requiring a college degree have enjoyed a strong job market and bargaining power for years now. 

Yet TD Securities economist Millan Mulraine argues that the shortfall was “driven by one-off factors that should unwind” in coming months. Specifically, the whole source of the undershoot resulted from “a sharp falloff in incentive pay this quarter.” This means sales commissions and performance bonuses came in rather light, which doesn’t seem like a clear reflection of the underlying employment trend. 

There was also some noise in the benefits calculation relating to how retirement plans are treated, which, again, might not reflect the ongoing reality. 

As a much broader issue, the ECI doesn’t fully capture the very hottest pockets of the job market, such as for engineers and other tech-adept workers on the West Coast. Tech companies this earnings season have alluded to the extreme scarcity of tech talent, and things such as generous restricted-stock packages and other equity perks don’t show up in the ECI. 

This is not to say that the ECI release should be dismissed. It’s always dangerous to try to explain away an indicator to serve a preset narrative about the economy. The monthly employment report next week will, in any case, help fill out the picture well before any Fed call needs to be made. 

Don Rissmiller, economist at Strategas Research Partners, says this ECI release was enough to make him move to December from September as his “base case” for when Fed interest-rate “liftoff” is likely to occur. 

While he acknowledges the “mixed bag” inside the report, with some “modest” reasons for hope within the components, Rissmiller says, “Given the degree of the miss,” this “only takes us from ‘disaster,’ to ‘not quite okay, at this stage of the business cycle, when labor should be taking share” of economic output. 

He concludes, “Still a broad-based weakness, which has to matter to a data-dependent Fed.” 

At minimum, it keeps the debates alive over the strength of the job recovery and the intentions of the Fed – at least for the rest of the summer.