US: Wages and inflation outlook remains benign - Nomura

Fed officials have been puzzled by benign wages and inflation against the backdrop of an economy approaching full employment, according to analysts at Nomura.

Key Quotes

“Prior to the crisis an unemployment rate nearer 4.4% could have been expected to coincide with wages growth of 3-4% and inflation tracking closer to 2%. Yet wages has been stuck in the low 2% range and inflation continues to fall shy of the Fed’s 2% objective. The relationship between wages / inflation and the labour market – the “Phillips curve” - appears to have weakened in the post crisis years.”

“Part of the conundrum can be explained by a misplaced focus on the unemployment rate as a barometer of labour market slack. The employment to population ratio has its quirks and does not distinguish between full time and part time workers but its less affected by movements in and out of the labour force, unlike the unemployment rate. Discouraged workers exiting the labour force all other things equal will flatter the true health of the labour market. The employment-population ratio places employment in the context of a much broader group of potential workers (i.e. the adult population). But, demographic forces such as an ageing society tends to skew the employment to population ratio so a narrow focus on prime aged (25-54yr olds) is an even better gauge.”

“Wages appear to have a better fit with the employment-population ratio and importantly appear to be running almost exactly where the still sub-par employment-population ratio predicts: about 2.5%.”

“There’s no mystery behind the benign wages and inflation picture – there is still considerable slack in the labour market. Wages growth of 3-4% are more typically seen when the employment-population ratio is above 870%. On current trends it will take almost two years for the ratio to hit that level. The Fed can afford to take its time.”