Episodes of high inflation often trigger worries about a “wage-price spiral”, a phenomenon whereby workers respond to high prices by demanding higher wages, with the resulting increase in nominal incomes putting further upward pressure on prices. This is a highly undesirable and destabilizing outcome. Is the US in real risk of a wage-price spiral or has the overall wage inflation already peaked?
Acute concerns persist regarding the outlook for both US and global inflation. While there are good reasons to believe that a new, higher-inflation regime may materialize (based on deglobalization, green transition, among other reasons), we also feel that too much is being made of the inflation surge in the past year. In our view, most of the current inflation spike reflects hugely distorted demand and supply dynamics that are bound to normalize. In fact, we believe that the process of normalization has already begun, facilitating a material and sustained deceleration in inflation close to pre-COVID-19 levels.
The steep rise in inflation over the past year was the result of market mechanisms at play as economic agents (consumers and producers alike) responded to new demand conditions. Indeed, it all started with demand and the extraordinary distortions introduced thereto by the pandemic. The core distortion had to do with the unprecedented surge in goods consumption during the pandemic – by the second quarter of 2021, real goods consumption in the United States (US) was 18% higher than it was at the start of 2020 (Figure 1).
Figure 1: Skewed Consumption Patterns Should Normalize
Even if the pandemic had not hindered productive capacity, we would still have witnessed an inflation spike since the system was simply not built to service the astronomical surge in demand. Of course, productive capacity was hindered as well, further exacerbating price pressures, and not just within manufacturing. All in all, the surge in goods demand not only triggered a production response but also a fervent scramble to move those goods into consumers’ hands.
Consequently, while overall payroll employment in the US is just returning to the January 2020 level, employment in sectors most directly connected to the goods economy has long since exceeded it. For instance, if employment in transportation and warehousing stood 12% above the January 2020 level in May this year, for couriers and messengers within the sector, it logged an incredible 23% above that level (Figure 2).
Figure 2: US Payroll Employment – Transportation & Warehousing
Unsurprisingly, this labor demand surge drove wage inflation in the sector to record highs (Figure 3). From the start of 2007 until the end of 2019, average wage inflation in transportation and warehousing was just 1.9%, but during the first five months of 2022, it jumped to 7.5% YoY! Similarly, according to the most recent monthly data, total average hourly earnings (AHE) in transportation and warehousing were up 7.8% YoY. And within the segment, average AHE for air transportation and couriers and messengers rose to 14.4% and 13.6% YoY, respectively. By contrast, back in January 2020, the three corresponding measures of wage inflation for these segments were at 4.2%, 4.0% and -2.2% YoY, respectively.
Figure 3: Surge in Labor Demand Drives Wage Inflation
It seems highly unlikely that these employment and wage parameters define the new sustainable equilibrium levels in the industry. Our macro forecast assumes that consumption patterns continue to gradually normalize, with US real goods consumption declining slightly this year and a little more in 2023. This should trigger a shift in wholesale and retail behavior and a move away from what had so far been a desperate drive to boost merchandise inventory levels to a more cautious approach. Less goods consumption and less inventory building will mean less people needed to move those goods across the country.
In light of this, it is not far out to suggest that employment levels in parts of the warehousing and transportation industry will decline by a little over the next couple of years, bumping up labor supply in other sectors. In conjunction with further improvement in the labor force participation rate, this should ease the intense wage competition for workers that has been so challenging for employers in general and small businesses in particular. This means, even if employment were to continue to show growth in other parts of the economy, wage pressure may experience a decline. Indeed, we suspect that overall wage inflation may have already peaked (Figure 4).
Figure 4: Wage Inflation May Indeed Have Peaked
It is important to remember that education employment is already back to the January 2020 level, professional and business services employment is 4.0% higher and healthcare employment is only 1.2% lower. Consequently, the scope for further rapid employment growth in these industries is limited. The one sector where employment remains considerably below pre-COVID-19 levels is leisure and hospitality, where payroll levels are still 7.4% below the January 2020 level.
We suspect it was from this space that a lot of labor migrated into the transportation and warehousing industry, forcing employers there to raise wages aggressively to either retain or attract workers. Those pressures may now be starting to ease. AHE in leisure and hospitality were 10.3% higher in May than a year ago, almost double the average for the entire economy. However, this is already three percentage points below the November-December peak and has further room for moderation.
We have long highlighted the importance of wage inflation in defining sustainable overall consumer price inflation. After all, absent a correspondingly rising stream of income, consumers would need to scale back real consumption to compensate for higher prices. In that sense, high inflation sows the seeds of its own demise. Given the dynamics discussed here, we are optimistic that the risk of a wage-price spiral is not high for the US economy.
The whole or any part of this work may not be reproduced, copied or transmitted or any of its contents disclosed to third parties without State Street Global Advisors’ express written consent.
The views expressed in this material are the views of Simona Mocuta through 30 June 2022 and are subject to change based on market and other conditions. This document contains certain statements that may be deemed forward looking statements. Please note that any such statements are not guarantees of any future performance and actual results or developments may differ materially from those projected.
The information provided does not constitute investment advice and it should not be relied on as such. It should not be considered a solicitation to buy or an offer to sell a security. It does not take into account any investor's particular investment objectives, strategies, tax status or investment horizon. You should consult your tax and financial advisor.
All information is from State Street Global Advisors unless otherwise noted and has been obtained from sources believed to be reliable, but its accuracy is not guaranteed. There is no representation or warranty as to the current accuracy, reliability or completeness of, nor liability for, decisions based on such information and it should not be relied on as such.
Past performance is not a guarantee of future results. Investing involves risk including the risk of loss of principal.
The trademarks and service marks referenced herein are the property of their respective owners. Third party data providers make no warranties or representations of any kind relating to the accuracy, completeness or timeliness of the data and have no liability for damages of any kind relating to the use of such data.
For EMEA Distribution: The information contained in this communication is not a research recommendation or ‘investment research’ and is classified as a ‘Marketing Communication’ in accordance with the Markets in Financial Instruments Directive (2014/65/EU) or applicable Swiss regulation. This means that this marketing communication (a) has not been prepared in accordance with legal requirements designed to promote the independence of investment research (b) is not subject to any prohibition on dealing ahead of the dissemination of investment research.
©2022 State Street Corporation – All rights reserved.
Tracking Code: 4826872.1.1.GBL.RTL
Expiry Date: June 30, 2023