Labor Market Tightness Could Undermine Inflation Consensus

Interest rates are falling, and a growing chorus is forecasting slower growth and tepid inflation. Consensus has shifted to a point where virtually all forecasters expect interest rates to follow inflation toward the cellar. Today’s flat inflation reading confirms that view. It has pushed the implied 5-year inflation forecast to a scant 1.7 per cent. Interest rates have followed those expectations lower: the benchmark 10-year Treasury note, which reached a 3.2 per cent yield as recently as November, has since slid to 2.7 per cent.

Though global growth is clearly slowing, inflation pressure is one trend that could upset the consensus.  Inflation, while not currently anticipated, could come from a tight US labor market.  Considering today’s 4 per cent unemployment rate, our model suggests wages will rise 3 per cent over the next 12 months; that’s on top of a 3.2 per cent gain over the last 12 months.

Tight labor conditions have emboldened workers. The “US Quits Rate” (the share of workers voluntarily leaving their jobs), currently 2.3 per cent, is hovering around its highest level in nearly 20 years. Work stoppages involving strikes and other labor disputes offer additional evidence: according to a recent report by the Bureau of Labor Statistics (BLS), more workers are engaged in work stoppages than during any period over the last 30 years. BLS figures do not include the impact of the government shutdown.  According to The Wall Street Journal, the largest source of labor unrest was public school teachers, who walked out in West Virginia, Oklahoma and Arizona. On a trailing 12-month basis nearly 700,000 workers were involved in work stoppages. This is the highest 12-month figure since 1982 when, by the way, the inflation rate was 3.8 per cent.

 – Jack Ablin, Founding Partner & Chief Investment Officer