Wage inflation likely to have picked up further in December

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As expected, the Fed increased the Fed funds rate at its December meeting, exactly seven years after it lowered the Fed funds rate to zero. While PCE core inflation is still subdued, the development of the labour market is key to understanding why the Fed has begun tightening monetary policy. From January to November 2015, non-farm payrolls increased by 200,000 per month on average and the unemployment rate was 5.0% in November, which is within the Fed’s NAIRU range. Also, wage growth has begun to pickup, suggesting that underlying domestically generated inflationary pressure is increasing. Besides that the Fed would very much like to see PCE core inflation picking up, the development in the US labour market will be a key determinant for the hiking pace.

We estimate non-farm payrolls increased 200,000 in December in line with the recent trend but below our own model, which suggests around 160,000. However, the lower model estimate is due partly to the weak jobs report in September. Our trend employment growth models still point towards employment growth around 200,000 per month. We estimate that employment growth in December was driven by private services. We estimate the unemployment rate was unchanged at 5.0%.

We estimate that average hourly earnings (AHE) grew 0.2% m/m in December, implying an increase in the annual growth rate from 2.3% y/y in November to 2.8% y/y in December, the highest since June 2009. This is in line with the consensus view. The annual growth rate in AHE is by nature volatile but still it is noteworthy that the annual growth rate in average hourly earnings trended up in 2015, suggesting that the Phillips curve is still functioning well. We expect wage growth to continue trending up in 2016, as we expect the labour market to tighten further.

General condition of the US labour market

In 27 November, we showed that one should not expect a rebound in the US participation rate. In our base case scenario, we think the participation rate will be fairly stable in coming years, as more people will return to the labour force and thus offset the downward pressure from the aging effect. In the medium term, when the labour market slack has vanished completely, we expect the participation rate to decline further due to the aging effect. This implies that we expect the labour force to grow in the range 100,000-150,000 per month over the next few years. The labour market would tighten as long as employment growth exceeds this. If we are right, the labour market should continue to tighten even if employment growth slows. We expect the unemployment rate to get below NAIRU early next year, which should boost wages and thus increase the underlying inflationary pressure further.

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