Do Rising Jobs and Payrolls Necessarily Mean Higher Inflation?

Tremendous growth in productivity of the last few years continues to strengthen our economy.  The latest evidence comes as the government reports that employers paid the biggest wage increases in a year, rising .4% last month, twice economists’ expectations.  Employers also created more jobs as payrolls grew by 207,000 last month, the biggest increase in three months.  Still, theU.S.unemployment rate held steady at 5% as more workers entered the labor force in search of jobs.  The civilian labor force increased by 450,000 in July, the Labor Department said. Of those, 438,000 found jobs.

There are two ways to interpret the wage increases.  The pessimistic view that has prevailed for months is that inflation fears remain alive and the Fed will continue its campaign of rate increases.  But in fact, inflation is not rising, it is falling.  The CPI core rate has fallen from its peak of 2.4% in February to 2.0% in June.  The release for July comes on August 16th.  Prices at the producer level are also on the decline.  The June reading with volatile food and energy removed was down to 2.2% from its steady level of 2.6% from January through May.  The second more optimistic view is that productivity has made wage increases possible, without resulting in price increases.  More money in the pockets of workers means more spending power, even in the face of higher gasoline and oil prices.

It will be important in the coming months to monitor rising wages from the employers’ perspective – labor costs.  If productivity increases slow, labor costs will likely rise faster than employers can pass them along as higher prices to their customers, and profits will suffer.  But now the pace of investment in technology, plant, and equipment seem to be sufficient to support the continued growth of productivity.  The latest round of quarterly earnings reports also supports the thesis that American business is healthy indeed.

Net positive surprises in earnings so far this quarter represent nearly 55% of those reporting, the 3rd best results on record, according to Credit Suisse First Boston.  They are coming in at an average of 4.8% above expectations.  Credit Suisse goes on the say that unit labor costs are not rising at 4% as they earlier expected, but are much more muted, even falling a bit.  That’s great news because what is being recorded as wage inflation is actually employment growth.  As of August 3rd, 1152 of the 1,631 companies in the Dow Jones U.S. Total Market Index had reported earnings and were up an average of 22% over the same period last year.

For the last couple of days investors seem to be taking the negative view that inflation may be on the rise again.  At least, the fear that the Fed may think it is which will cause them to raise rates further is having a dampening effect on yield-driven investments.  Real estate stocks and dividend paying stocks are the targets of today’s traders and profit-takers.  Treasuries are down as much as a half a percent in the longer maturities.

We simply have to wait to see what the Fed will do with rates.  They are about the only rainmaker in town now.  The steady release of corporate earnings and economic data continue to be positive.  Time will tell.