The US is bouncing back strongly from the Covid-driven recession, as vaccination rate climbs and states reopen their economies. With robust growth momentum comes the concern about overheating: after years of inflation undershoots investors and policymakers are faced with two consecutive months of above-3% core CPI prints. So far the Fed has largely dismissed the inflation upturn as transitory. Indeed, most of the upside surprises in the latest CPI prints came from Covid-related categories like used cars, airfares, and household furnishings, where outsized price surges will not continue indefinitely. The real risk to this “transitory inflation” narrative, however, will likely come from an interplay of sustained increases in wages and inflation expectations, commonly known as a wage-price spiral. With average hourly earnings beating consensus consecutively and numerous news stories on labour shortages, is the US getting closer to such a spiral?
Constrained Labour Supply Is Pushing up Wages in Some Sectors
Despite the strong cyclical recovery, payroll growth in the US has been slower than expected: 278k and 559k jobs were added in April and May respectively, underperforming consensus and leaving the economy still 7.6mn jobs lower than the pre-Covid level. However, a deeper look into the labour market statistics by sector suggests that the bottleneck to job recovery is more on the supply side, rather than the demand side.
A useful metric advocated by Fed’s Bullard recently is the ratio of unemployment to job openings. As shown below, the number of job openings relative to the number of unemployed people has been rising across most sectors and exceeded 100% for most services sectors. In other words, there are more job vacancies than unemployed people across sectors, and firms are struggling to fill the vacancies. As a result, wages are growing faster, as indicated by the upward movements in 3-month trailing growth rates of average hourly earnings.
This dynamic between job demand-supply imbalances and wage growth is more pronounced in selected sectors like Leisure and Hospitality, Profession and Business Services, as well as Manufacturing. In particular, average hourly earnings for Leisure and Hospitality jumped by 4% over the past three months, even though the sector still has 2.5mn of lost payrolls that are yet to be recovered.
What Is Holding Back Labour Supply?
Many people have attributed the sluggish labour supply to the enhanced unemployment benefits, as evidenced by the slow job recovery in the low-paid Leisure and Hospitality sector where the disincentive effects of the $300-per-week benefits are the strongest. As a result, 25 states have already announced that they would end the enhanced benefits in June or July, ahead of the scheduled expiry in September. On the one hand, the early lifting of enhanced benefits could propel more labour back into the workforce, as signaled by the brief jump in job search activity in states that made the announcements. We are likely to see such impact, if any, reflected in official data in July at the earliest. On the other hand, a by-state analysis suggests that there are more factors at play than just unemployment benefits.
Comparing the labour market recovery trajectories of states that are ending benefits early vs those ending late, there already seems to be notable differentiation. Total payrolls in states that are ending benefits early are -3.6% lower than pre-Covid levels on average, compared to -7.0% in states that are ending benefits late. This is despite the faster vaccination progress in states that are ending benefits late. Looking deeper into the by-state data, the explanation seems to lie with Covid-related policy restrictions. In general states that are ending benefits late have taken a more cautious approach towards Covid by imposing more stringent policy restrictions for longer, as indicated by the Oxford Policy Stringency Indices below. For example, California and New York, the two big states with the most unrecovered payrolls, only lifted most of their Covid restrictions by mid-June. Lingering restrictions and correspondingly people’s remaining fear of Covid likely have also slowed down the come-back of labour supply.
As illustrated below, there seems to be a clear negative relationship between job recovery and policy stringency. There could be different ways in which policy restrictions are slowing down the return of labour. For example, states that have kept school closing requirements for longer are often also the ones with slower job recovery. The need for more childcare attention might have been a major impediment to labour supply.
To sum up, most data evidence suggests that constrained labour supply in the US is driving faster than expected wage growth and slower than expected payroll recovery. However, it is still too early to say whether such strong wage growth would continue, leading to more persistent inflation pressure. There are still several temporary impediments to labour supply recovery, ranging from enhanced unemployment benefits to lingering Covid restrictions. We are only likely to get a better idea of the more structural labour market dynamics in the coming months.
Tao Pan – Head of AI and Big Data, Algebris InvestmentsThe Algebris Policy & Research Forum (the "Forum") is a not-for-profit advisory forum, independent of the commercial activities of Algebris (UK) Limited. The Forum is designed to contribute to the promotion of a strong and a balanced European economy, underpinned by a sound financial system and supported by a transparent regulatory and fiscal environment, for the benefit of societies as a whole. The primary focus of the Forum is on publishing expert reports, recommendations on European economic policy issues and sharing expert knowledge and research with the public, governmental and non-governmental institutions.
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