The labor market is almost full as the prime age employment to population ratio is nearing the 2007 and 1990 peaks and the underemployment rate is in between the past two cycle bottoms. Firms in many industries are complaining they can’t find qualified workers. There’s a catch to that point. They can’t find qualified workers for the wages they want to pay, but they would be able to find qualified workers if they raised salaries. Raising salaries means prices need to be raised or margins will fall. That’s a tough decision, but employers need to realize the labor market is tightening and get with the times.

The chart below shows the quit rate measuring the number of workers quitting their jobs for better opportunities, which can act as a leading indicator for the Employment Cost Index. 

Source: The Daily Shot

In this chart, the quit rate is ahead of the ECI by 1 year. The correlation is high in the past 16 years. It implies wage growth will continue. This isn’t a shocking proposition as a tightening labor market and decent productivity growth mean wages will increase. The areas with the highest wage growth should be jobs filled by workers without a high school diploma because that demographic has the highest employment to population ratio ever.

Wage Growth Doesn’t Mean Price Inflation

Wage growth can mean price increases for individual businesses because they need to offset increasing costs. However, when you look at the whole economy, average hourly earnings growth for production and non-supervisory workers hasn’t led to increased core PCE inflation. Commodity inflation has been weak in 2018. The Fed is hiking rates because it expects inflation to increase in 2019. It’s problematic if the Fed is increasing rates because of wage growth because the chart below shows it hasn’t pushed core PCE higher. 

Source: Barclays Research

One catalyst of inflation could be the tariffs. The problem for the Fed is tariffs can slow the economy and increase prices. That’s a tough problem to solve. The Fed might decide to be patient and hope both sides decide to end the trade war by making a deal.