November jobs report: Wage growth accelerates, sending mixed signals on inflation

Two important clues for where the U.S. economy is heading were released last week. Unfortunately, they each pointed in opposite directions. On December 1, the Personal Consumptions Expenditure (PCE) price index suggested slowing inflation. However, on December 2, the Employment Situation report showed accelerating wage growth, which is thought to be a major contributor to higher inflation. 

Here are our thoughts on what this really means for the economy and your portfolio.

Inflation slowed in October

The PCE inflation report confirmed what the Consumer Price Index report indicated two weeks prior: inflation slowed significantly in October. For just the month, Core PCE inflation, which excludes food and energy, only advanced by 0.22%. That's down from 0.46% last month and about half of the 0.40% average for the year's first nine months. Note that the Core PCE inflation index is the one the Federal Reserve uses for their 2% inflation target, so the fact that this report showed inflation slowing similarly to the CPI is particularly important.

Similar to the CPI, the most encouraging part of the PCE inflation report was so-called "durable goods" prices, which declined by 0.6%. Essentially durable goods encompass any physical good that is not consumed. For a few months, we've been hearing from retailers that their inventory of unsold goods was growing. Usually when this happens, stores put these products on sale to clear their excess inventory. Now, this phenomenon appears to be showing up in inflation reports.

Wage growth accelerated in November

As encouraging as the PCE inflation report was, the Employment Situation report, which came out the next day, reminded us that we're not out of the inflation woods yet. Usually, when this report is released, we focus on the number of new jobs gained, which for November was a very respectable 263,000 added to payrolls. That's down from an average of 444,000 per month during the first half of the year but is well within the normal range for non-recessionary periods.

The surprise came from the Average Hourly Earnings portion of the report, which suggested that wages rose by 0.6% this month. According to Bloomberg's Forecast Survey, that was double the pace economists expected.

What's wrong with wages rising?

Typically, rising wages are a good thing, but when inflation is running too high, it can present a problem. Inflation is caused by spending outpacing the economy's ability to supply goods and services. Consumers can't keep increasing their spending level unless they have more dollars to spend. For the vast majority of households, wage income is their primary source of dollars spent. Therefore, if we see a resurgence of wage increases, renewed inflation pressure may follow.

Most measures suggest labor market is softening

We usually expect higher wage growth to be a function of a tight labor market. E.g., one where companies cannot find enough workers and are aggressively raising pay to entice employees from other firms. If we took this most recent wage number at face value, we might worry that the labor market is getting even tighter. However, this surprisingly high wage growth figure conflicts with just about every other measure we have of where the labor market is headed.

In the first half of 2022, total payrolls rose by an average of 444,000 jobs per month. The November figure of +263,000 represents a 41% decline. Job openings were as high as 11.9 million earlier this year but have since declined to 10.3 million, a 13% decline. Announced layoffs by U.S. companies averaged 22,000 per month in the first half of 2022. In November, that figure was just under 77,000. Average weekly hours worked per employee was 34.4 in November, which is the lowest since April 2020. You'd think that if employers are desperate for workers, then the workers they have would be working longer, not shorter, hours.

If you spend a lot of time analyzing macroeconomic data, you quickly realize that no one statistic can tell the story. Every measure you find has certain flaws that can cause it to give the wrong impression at times. The way around this is to look at various indicators and see if together they tell some cohesive story. 

In this case, the combination of various indicators suggests that the labor market is softening a bit. The sudden jump in wages in November looks like an anomaly compared to all the other data we have.

We will see how the data evolves from here, but if the job market is cooling, the odds are good that wage growth will also slow. 

What does this mean for my portfolio?

In the short term, the most important thing markets are hoping for is slower inflation, allowing for a slower path of Fed rate hikes. We're seeing two important trends that may support both: actual inflation estimates slowing and the labor market softening. 

We already expect the Fed to slow its pace of rate hikes to only 0.50% at their December 14th meeting vs. 0.75% at the prior four meetings. If these trends continue, the Fed may slow the pace of hikes even further in 2023, possibly even pausing hikes entirely sometime in the spring. We think that would support both stock and bond prices appreciating from here.