Fed Hiking Into Weakening Economy

The economy is seeing a modest pickup in inflation even as GDP growth slowed to 2.3% in Q1 of 2018. That puts the Fed in a difficult position as it balances the dual mandate of having stables prices and maximum employment. One of the latest critiques of the Fed is that by raising rates after wage growth accelerates to a certain point, the Fed is defending the interests of corporations at the expense of workers. While inequality is high and corporate profit margins are high, inflation is not only driven by the labor market. Furthermore, people don’t benefit if they get nominal wage gains, but the price of goods go up so much that their real wages fall. Controlling inflation controls the value of the purchasing power of consumers. To be clear, the Fed is not the best manager of the currency’s purchasing power. 2% inflation, the stated objective of the central bank, is a 2% decline in the value of the currency, which is the opposite of price stability.

Wage Inflation Is Increasing

Another fair criticism is the Fed is hiking rates too soon because the labor market isn’t completely full. Measurements of wage growth, which is a pivotal indicator of whether the labor market is filled, vary. The Atlanta Fed wage growth tracker peaked at 3.9% in October and November 2016. In March 2018 it was at 3.3%. It’s fair to say that this index suggests there’s more room to run before the labor market is filled. Growth peaked at 4.4% in September 2007.

Labor Market Not Full

The chart below shows another measurement called the Employment Cost index.

Source: Econoday

For March, this report showed 2.7% year over year growth which was an increase of one tenth from the previous month. As you can see from the chart below, this index implies the labor market is nearing its cycle peak.

Core PCE Nearly Hits The Fed’s Target

Core inflation is the Fed’s primary measure of inflation. The goal is 2% core PCE inflation. In the March report, core inflation missed expectations for 2%, coming in at 1.9%. That’s still a sign of increasing inflation pressures because the previous report showed only 1.6% inflation. The Fed is worried that this bout of modest inflation pressure will be stronger than the previous ones in this expansion because the labor market is nearly filled. Although it’s not part of the core number, rising oil prices, which usually occur at the end of the business cycle, are also leading to higher economic costs.