Markets: Wages Are Running Hot. What Does That Mean for Costs?


Capital Markets Perspective brings you what to watch in the markets this week, published in partnership with Great-West Investments.

Week in Review

March 28– April 3

This weekend, I was introduced to the wonderful world of “Wordle.”

For those who aren’t familiar, Wordle is a crossword-like game owned by the New York Times in which you have six tries to guess a five-letter word by choosing other five-letter words that have letters in common with the solution: it’s kind of a mash-up of “Jumble”, “Wheel of Fortune” and the vaunted NYT crossword all rolled into one. (If you haven’t already, check it out – it’s a great way to waste a lot more time than you ever intended…)

So for this week’s edition of Capital Markets Perspective, I thought we might use the obnoxiously addictive brainworm that is the Wordle framework to illustrate a point: by connecting five-letter words that appear in one economic release to other five-letter words in other releases, we might eventually reach another five-letter word “solution” that tells us a little something about where we’re at in the economic cycle.

Our first five-letter word is “WAGES.”

“Wages” appeared in several places last week, most prominently in Friday’s payrolls report from the Bureau of Labor Statistics, which showed hourly earnings up a robust 5.6% year-over-year – slightly ahead of expectations[1]. But at least in concept, “wages” appeared in another report, too – the Bureau of Economic Analysis’ income and outlays report – on Thursday. According to the BEA’s data, compensation costs are up an even more robust 8.8% compared to last year[2]. There are valid reasons that the two figures would differ so much, but we won’t worry about them for now: it’s enough for our purposes to know that two different sources confirmed that wages are up quite a bit since last year.

Our next word is “COSTS.”

The link between “WAGES” and “COSTS” is of course pretty straightforward – as wages rise, businesses have two choices: they can “eat” those higher costs (and become less profitable,) or they can pass them on to their own customers (and thereby contribute to the rising tide of inflation that is so completely defining the economic narrative these days.) As last week’s data shows, some businesses are increasingly choosing the latter by passing on costs to their own customers to a greater extent than they had in the past. For evidence, the “prices” component of last week’s manufacturing PMI report mentioned that “the rate of cost inflation remained marked and quickened in March[3].” That conclusion was echoed by similar data compiled by the Institute of Supply Management, whose own index for price data rose back toward its record high in March, with rising energy costs related to Russia’s invasion of Ukraine getting a majority of the blame[4]. Once again, two sources, one conclusion: we’re not done with inflation just yet.

Our next word: HOARD.

This one isn’t quite as obvious. As businesses face higher costs, they again face a choice: should they pull in their horns and try to wait it out, or should they increase their buying activity to get out in front of even higher prices in the future? Increasingly, businesses may be choosing the latter, evidenced by the appearance of that dreaded word “stockpiling” in the very same manufacturing PMI report I mentioned above: “…some firms linked the rise in new orders to stockpiling at customers amid steep increases in selling prices[5].” As I’ve mentioned before, I have nothing against stockpiling behavior per se, particularly if inventories are abnormally low (which, at least according to recent inventory-to-sales ratios, they are[6].) But when stockpiling behavior becomes hoarding behavior, demand can quickly overheat and lead to dangerous disconnects that eventually have to be reconciled by rapidly declining demand as excess inventory built during the manic phase of an inflation spiral has to be worked down. We’re nowhere near that yet, but with words like “stockpiling” starting to show up in survey-based economic data, it’s a risk that we’ll probably want to pay more attention to in the near future.

Next up: CHOKE.

Ah, another relationship that seems pretty clear: As the economy starts to run a little too hot and things like wages and costs eventually rise enough to frustrate would-be buyers, supply chains can sometimes choke on all those higher costs and surging demand. (Sort of an alternative ending to the “stockpiling” story we built above.)  But here the news was actually somewhat positive last week. Those same ISM and PMI reports that contained little seeds of concern on prices and demand also mentioned – anecdotally – that businesses are finally starting to see supply chain pressures ease a little bit, including news that “vendor performance” – the PMI’s way of measuring supply chain stress by asking firms how often their suppliers have disappointed them recently – worsened less in March than in recent months[7]. The fact that this is occurring even as the war in Ukraine rages on is a little surprising, but we’ll take whatever we get.

Which leads us to this week’s five-letter macroeconomic Wordle “solution”: PAUSE.

Last week’s daisy-chain of data runs thus: WAGES are running hot, which means business COSTS are still rising. That means our bout with inflation isn’t quite over and could even be creating an incentive for firms to HOARD, even as supply chains seem a little less apt to CHOKE on all the demand surging through the system. Little wonder, then, that markets are beginning to increasingly question whether all these inter-connected five-letter macro-relevant words might ultimately cause the economy to PAUSE.

On Thursday, that fear became a little more tangible in the form of an inverted yield curve at the 10-to-2 year spread: a far more conventional measure of recession worries than the 5-year / 30-year spread that we tortured half-to-death last week with a Top Gun analogy. As we’ve gone to great pains to point out in the past, an inverted yield curve – whether at the 10-2 spread, the 5-30 spread or any other spread you care to measure – doesn’t necessarily mean recession is imminent. But it certainly raises a few eyebrows, and the fact that the inversion has now gone mainstream might suggest that a slowdown in the relatively near future is a very real and growing possibility.

Finally, let’s close the discussion of last week with a bonus Wordle: SHIFT. Last week’s payrolls report, mentioned above in the context of rising wages, probably did very little to shift the Fed’s thinking. That’s because it was neither too weak to cause the Fed to pull back the pace of rate hikes, nor too strong to cause them to accelerate the pace of normalization much beyond the 0.5% increase that has now become consensus. Instead, payroll creation was more or less right down the middle of the fairway, with a total of 431,000 jobs added in March.[8] That, plus a welcome increase in labor force participation, was just enough to be considered forward progress, but still short of levels that would cause the Fed to freak out and over-compensate.

Of course, if you’re at all familiar with Wordle, you know that the above chain, WAGES > COSTS > HOARD > CHOKE > PAUSE, violates just about every Wordle rule except the one that requires you to use only five-letter words. But you have to admit, it makes a lot more sense from a macroeconomic point of view than it does from a game-play perspective: as you link one word to the next and to the next, you start to get a fairly comprehensive view of what the data might be signaling about what lies ahead for the economy: namely, growth for now but uncertainty looking forward.

What to Watch This Week

April 4–April 10

Notable economic events (April 4– 8)

Monday: Factory orders

Tuesday: PMI/ISM services, ECB minutes

Wednesday: Fed minutes, EIA petroleum inventories

Thursday: Weekly jobless claims

Friday: Wholesale inventories

It’s a very light week from a scheduled release perspective, which could leave Ukraine-related news flow to fill the void. But attempting to predict what might or might not happen in Europe when a nutty little dictator is still calling the shots is next to impossible, so I won’t even try. Instead, let’s focus on the things we can rely on to set the tone.

First up are Wednesday’s Fed minutes, a detailed view of what was said (even if not exactly who said it) during last month’s FOMC meeting. Of particular interest will be any inferences relating to when the Fed might start shrinking it’s massive $9t balance sheet: now that rates are no longer pegged at zero, the main philosophical impediment to begin running off of all those Treasury- and mortgage bonds the Fed bought during the pandemic has been removed. Powell & Co. carefully sidestepped the issue of the timing of that run-off during the post-FOMC news conference a few weeks ago, but any color surrounding the debate that appears in the minutes could be enlightening. Ditto for any hints about whether the market is justified in its assumption that a few half-point increases might be on tap for this spring and summer.

But before the Fed watchers have their moment, those who follow the European Central Bank will have a chance to weigh in: the ECB releases its meeting notes on Tuesday. While the Fed and the ECB aren’t exactly in lock-step, they are both certainly aware of what the other is up to. That means Tuesday’s ECB minutes might contain a hint or two of what might have found its way into the Fed’s debate last month.

Next on the list in terms of importance is probably Tuesday’s ISM/PMI releases for the services sector. Last week’s read on the manufacturing sector was generally strong, but showed businesses still beset by some of the same pressures that we’ve been writing about for months: namely, higher prices, tight labor markets and wobbly supply chains. Last week’s manufacturing releases contained at least some good news about supply chains, and a parallel performance by the services sector would be welcome indeed.

On Wednesday, the Energy Information Administration will release its weekly read into oil and refined product inventories. We have rarely paid much attention to that data in these pages, but with oil and oil inventories at the top of just about everyone’s list of things that can sway sentiment, Wednesday’s EIA data could be notable. Depending on where you live, crude oil inventories are either low or really low, with most areas of the country below 5-year ranges for oil stockpiles (the exception seems to be PADD 4 – the Rocky Mountain region[9]. But as a resident of the region, I can confirm that this hasn’t meant much relief for gasoline prices so far…)

Finally, another datapoint that rarely gets much attention – wholesale inventories – might also be worth a closer look than we’re accustomed to giving it. If you were following the discussion above about stockpiling and panic-buying, you might be inclined to pay a little more attention to this easily overlooked data (which will be released on Friday.) My own view is that while some increase in inventories would indeed be healthy at this point, this is a data series we’ll want to follow closely in coming months to see whether demand might be setting itself up for a reckoning at some point later this year.


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[5] Ibid.


[7] Ibid.