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A Framework That Provides Clarity

During periods of “low visibility,” confusion reigns: for every indication of one trend, there seems to be a countertrend. The key is to glean from the collective wisdom of reliable leading indicators a clear signal that the economy is headed for a turn.

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Earnings Growth Upturn Masks Labor Market Weakness


Earnings growth has risen for an unwelcome reason – because growth in hours has fallen faster than pay growth. As bad as that is for income growth, it is also not a credible signal of an inflation upturn.

Given the ongoing taper, the Fed, like most other observers, remains optimistic about economic prospects. In turn, a number of economists are focusing on “bullish” indicators of employment and inflation, particularly growth in average hourly earnings (AHE), which has been rising since late 2012. This strengthening has been taken by some to mean there is less slack in the labor market and wage growth is rising. Yet, is the rise in AHE actually indicative of strengthening labor-market fundamentals, particularly inflationary pressures? We turn to our cyclical framework for answers.

For the overall private sector, year-over-year (yoy) growth in AHE has indeed risen noticeably since October 2012.



Since AHE is the ratio of total weekly pay to total weekly hours, it is instructive to look at the growth rates of each, shown in the lower panel of the chart (purple and gold lines, respectively). From this perspective, the real story emerges. Year-over-year growth in both pay and hours has actually been falling since early 2012, with the declines steepening since last summer and the divergence between the two increasing, particularly in recent months. In other words, while rising yoy AHE growth may seem like a good thing, in this case it is actually underpinned by cyclical downturns in the components that comprise it.

Clearly, there are both straightforward and misleading reasons for increasing AHE growth – those which stem from underlying strengthening of hours and pay growth, and those which arise from a technicality, where both indicators are actually falling, or are little changed.

The bottom line is that the current rise in overall AHE growth is not a sign of strength. In most industries, yoy AHE growth has either declined, been essentially unchanged, or has risen for misleading reasons, proffering false hope.

Therefore, the commonly-touted “upturn” in earnings growth is largely illusory, and does not really point to a healing in the labor market, or necessarily imply a welcome rise in inflation, as some claim. It is risky to presume, based on AHE, that policy action has effectively achieved its goals of boosting inflation and healing the labor market. This is even more troubling in the context of the “yo-yo years” environment of weakening trend growth and more frequent recessions than most expect.

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