Wages vs. Inflation

US inflation has significantly slowed over the past year as the Federal Reserve took aggressive measures to increase interest rates, aiming to curb demand and reduce price inflation. While wages haven’t cooled as much, there’s constant speculation about the implications of each monthly jobs report on the Fed’s decisions.

The central bank will continue to closely monitor the state of the labor market, particularly focusing on wages, as part of its strategy to combat inflation. However, labor data can only reveal so much about future price increases.

The main issue is that wage figures are excellent indicators of inflation’s current status but are not reliable predictors of its future direction.

inflation
Rumors of the US dollar’s demise continue to be greatly exaggerated,” James Athey, investment director at Abrdn, a UK-based global investment company, told CNN. Source/Internet.

Chicago Fed President Austan Goolsbee emphasized this point in an interview with Bloomberg after the July jobs report showed an increase in wage growth. He stated that wages are “not a leading indicator of price inflation.” Atlanta Fed President Raphael Bostic also noted that despite the period of high inflation, worker wages had lagged behind inflation for quite some time, and strong wages were expected to continue.

The August jobs report, released earlier this month, showed a slowdown in wage growth and an increase in the unemployment rate to 3.8%. While financial markets often react to labor data, it’s the actual inflation data that holds the most significance for the Fed.

Quincy Krosby, Chief Global Strategist for LPL Financial, emphasized that the trajectory of inflation would ultimately drive the Fed’s rate decisions, noting that “inflation remains sticky.”

Fed officials have acknowledged that the tight labor market has contributed to elevated inflation levels. They are considering another rate hike later this year, given the clear connection between labor costs and inflation, especially for service-based businesses where labor is the most significant cost.

If labor costs rise due to higher wages and aren’t accompanied by corresponding productivity growth, businesses may pass those costs on to consumers, potentially leading to higher consumer prices.

The challenge in predicting inflation using labor figures lies in productivity data. Wage growth not accompanied by productivity growth has historically been correlated with inflation. However, productivity data are reported quarterly, making them less real-time than monthly payroll figures and subject to significant revisions.

This means that labor market data and wage growth can explain inflation but are less reliable at predicting it. To determine if inflation is being effectively managed, monitoring inflation itself remains the best approach.

The US dollar has recently strengthened significantly, enjoying its longest winning streak in nearly nine years. It has gained 5% since mid-July and is heading for its eighth consecutive week of gains against a basket of major currencies. This rally comes after months of volatility fueled by concerns about the dollar’s status as the world’s reserve currency, particularly following the expansion of the BRICS group to include major oil producers like Saudi Arabia.

James Athey, Investment Director at Abrdn, emphasized that rumors of the US dollar’s decline are overstated, underscoring the dollar’s resilience and strength in recent months. The US Dollar Index, now at its highest level in six months, has been bolstered by positive economic data, leading to expectations that the Federal Reserve will maintain higher interest rates for an extended period. Higher interest rates tend to attract more foreign capital, increasing the value of the US dollar.

See also: US Dollar ‘s Winning Streak

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