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Will an Overheating Labor Market Lead to Inflation and Further Interest Rate Hikes?

Written by Jeff Brown | June, 2018

Time to read: 4 minutes |

In the last few weeks, we have seen several economic reports that paint a strong US employment picture. Non-Farm Payrolls reported over 229,000 jobs added in May, bringing the unemployment rate down to 3.8%, the lowest level since April of 2000. In addition, the recent Job Openings and Labor Turnover (JOLTS) report showed more job openings in the US than people looking for work. This shift in balance is a first since the records began in December of 2000. Finally, as the chart below demonstrates, initial unemployment insurance claims are at their lowest level since 1969.

Looking at this strong evidence of a tight labor market, surely wages must be rising, right? In the chart below, you can see that over the past year and a half, wage growth has been relatively stable . However, the growth in average hourly earnings climbed to a new cycle high of 2.8% year-to-year in May. This small but significant breakout to the upside may indicate a rising wage environment.

Our view is that the traditional unemployment rate may hold the key to higher broad-based inflation. The next chart compares the unemployment rate with what is considered “full employment.” When unemployment drops well below “full employment,” labor is scarce.

If history holds true, this scenario would result in rising compensation for workers which should, in theory, begin to trigger inflation. Should that situation occur, the Federal Reserve may have to increase the speed of interest rate hikes, which could have a corresponding effect on many financial markets. 

We hypothesize that the Federal Reserve will continue on the normalization path that the markets now expect, but we will be watching these indicators closely for signs of an overheating labor market. We are currently underweight in fixed income and own mostly short and intermediate duration bonds in expectation of a steadily rising rate environment. If it appears that the Fed will move more urgently, we will take action accordingly by further cutting exposure to bonds and their duration.

 

 

The economic forecasts set forth in this material may not develop as predicted and there can be no guarantee that strategies promoted will be successful.

Stratos Private Wealth is a division through which Stratos Wealth Partners, Ltd. markets wealth management services. Investment advisory services offered through Stratos Wealth Partners, Ltd., a registered investment adviser.  Stratos Wealth Partners and its affiliates do not provide tax, legal, or accounting advice. This material has been prepared for informational purposes only; and is not intended to provide, and should not be relied on for, tax, legal, or accounting advice. You should consult your own tax, legal, and accounting advisors before engaging in any transaction. Content in this material is for general information only and not intended to provide specific advice or recommendations for any individual.  To determine which strategies or investments may be suitable for you, consult the appropriate qualified professional prior to making a decision.  Investing involves risk including possible loss of principal. Some of the information contained herein has been obtained from third party sources which are reasonably believed to be reliable, but we cannot guarantee its accuracy or completeness. The information should not be regarded as a complete analysis of the subjects discussed.