INDICATOR: Fourth Quarter Employment Costs and December Income and Spending
KEY DATA: ECI (Year-over year): +2.0; Wages: +1.9%/Real Disposable Income: -0.2%; Real Consumption: +0.2%
IN A NUTSHELL: "Weak income growth may be keeping labor costs under control but it is also keeping spending down as well."
WHAT IT MEANS: If you wonder why earnings are solid while growth isn't, just look at employment costs: They are going nowhere. The Employment Cost Index rose modestly in the fourth quarter and when adjusted for inflation, it barely budged. Over the year, compensation rose just a touch faster than inflation. Wages and salaries as well as benefits increased at a less than one percent pace over the year when inflation is considered. Interestingly, private sector wages rose faster than in the public sector and nonunion wages increased at a faster pace than union wages. The issue of income is key since it is hard to get strong growth if people don't have more to spend (broken record time). It looks like we are not likely to see that strong growth for a while as incomes, adjusted for inflation (real income), actually declined in December. Comparing 2013 to 2012, real, or inflation-adjusted compensation from all sources of income rose just over 1%, half the pace that total consumption rose for the year. That is not sustainable and households are taking money out of savings. The savings rate dropped from 5.6% in 2012 to 4.5% in 2013 and hit 3.9% in December. That is not a good trend. Consumers are trying to keep up the pace, and they did spend a fair amount in December, but with heating costs skyrocketing, there may not be much left over for other goods. Thankfully, consumer confidence is hanging in there. The University of Michigan's index eased in January but given the stock markets' declines and the weather, the drop was less than feared.
MARKETS AND FED POLICY IMPLICATIONS: Businesses have done a spectacular job controlling their biggest expense, labor costs, but no good deed goes unpunished. Personal income, the fuel for spending, is also well contained. Will that change anytime soon? I think by the end of the year, the compensation picture will be turning on its head. It is all about labor supply and that means the unemployment rate is the key measure. We get the January numbers next Friday and there are some statistical adjustments occurring, so the new numbers may be a bit different. But assuming we start the year below 7% (the December rate was 6.7%), it is very likely we will drop under 6% before year's end. With full employment roughly 5.5%, shortages will be showing up in industries, occupations and regions. Asking people to work even harder will likely be met by that famous phrase, "take this job and shove it" as other opportunities will finally be available. The only alternative will be increasing compensation. Those firms that don't start planning for a changing wage situation now may be shocked and damaged when the labor market turns from excess supply to excess demand.