Seven hikes? Fast-rising wages could cause the Fed to raise interest rates even higher this year

The sign at the McDonald’s restaurant on Penn Ave in Sinking Spring, PA April 8, 2021 with a message on a blackboard below it reads “Work Here $ 15 And Free Meals.”

Ben Hast | MediaNews Group | Getty Images

Too much of the good, in the form of rapidly rising wages, is expected to push Federal Reserve rate hikes at an even faster pace.

Average hourly earnings rose 0.7% in January and are now running at a pace of 5.7% over the past 12 months, according to data from the Labor Department released Friday. Aside from a two-month period in the early days of the pandemic, it is by far the fastest movement ever in data dating back to March 2007.

Although it has come as welcome news for workers, it has posed a further dilemma for the Fed, which is increasingly seen as lagging behind in terms of policy and having to catch up with inflation, which is running at the fastest pace for almost 40 years. .

“If I’m the US Federal Reserve, I’m getting more nervous that it’s not just a few equalizations that are driving wage increases,” Ethan Harris, Bank of America’s head of global economic research, said in a media call Monday. “If I were the Fed chair … I would have raised interest rates early in the fall. When we get this broad-based increase and it’s starting to find its way to wages, you’re behind the curve and you need to start moving.”

BofA and Harris have issued the most aggressive Fed call on Wall Street for this year. The bank’s economists see seven – quarter percentage point rate hikes in 2022, followed by another four next year.

The economy is not just hitting the Fed’s goals, it’s blowing through the stop signs

Ethan Harris

Head of Global Economic Research, Bank of America

Harris said he is not backing the call, even though the markets currently only give the scenario an 18% chance of happening, according to CME data.

He cites the Fed’s new approach to monetary policy, which it approved in September 2020. Under what it considered a flexible average inflation target, the Fed said it would be willing to let inflation warm above its 2% target in the interest rate to achieve Full employment .

But with inflation at around 7% year-on-year and the labor market getting tighter, the Fed is now able to play catch-up.

“The problem with the whole approach, and what made us call for seven increases, is that the economy is not just hitting the Fed’s goals, it’s blowing through the stop signs,” Harris said.

Harris points out that wages are rising across virtually all income classes.

Leisure and hospitality, the hardest hit sector from the pandemic, has seen a 13% increase in earnings over the past year. Wages in finance jobs have risen 4.8%, while retail wages have risen 7.1%.

Goldman Sachs sees the push higher as part of “The Great Resignation,” a term used to describe the fastest pace of people leaving their jobs in data dating back to 2001. Throughout 2021, workers switched or left jobs 47.4 million times, according to the Ministry of Labor.

“The Great Resignation consists of two very different but connected trends: Millions of workers have left the workforce, and millions more have quit their jobs for better, better paid opportunities,” Goldman economists Joseph Briggs and David Mericle said in a note. “These trends have pushed wage growth to a pace that is increasingly raising concerns about the inflation outlook.”

Goldman estimates that wage growth will slow this year, but only slightly, to around 5% through the year. The company expects four interest rate hikes in 2022.

“Faster labor cost growth than is compatible with the 2% inflation target is likely to keep the FOMC on a continuous walking path and increase the risk of a more aggressive response,” economists said.

Markets have slowly increased their efforts for the Fed and have priced five rate hikes this year, but open up the possibility of more and faster. While traders see a movement at a quarter point in March, the possibility of a more aggressive increase of 50 basis points has risen to almost 30%. A base point is one hundredth of a percentage point.

“That’s how outdated and behind the Fed’s policy is,” Mohamed El-Erian, chief financial adviser at Allianz, told CNBC’s “Squawk Box” on Monday. “So hopefully they can regain the inflation narrative, hopefully they can control the wage narrative. My concern is that the market is running off with interest rate hikes that exceed what the economy can absorb.”

BofA’s Harris said it would be “a reasonable thing to do” to go for 50 basis points, although he noted that it would not be in line with the “humble” approach that President Jerome Powell spoke about during his post-meeting press conference. January.

Harris said he actually does not believe that rate hikes will ruin the economy as long as the Fed communicates that the measures will be methodical and aimed at controlling inflation, not stopping growth. This cycle could resemble the Fed’s move in the mid-aughts, as it launched a series of 17 hikes aimed at slowing the runaway housing market, he added.

“I actually think it’s not a radical call,” Harris said of the bank’s expectation of 11 increases through 2023. “It’s just the path to least resistance for a central bank starting at zero.”

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