Inflation Cycle Shifts Towards Services, Making It More Difficult For The Fed To Reverse
|in:Viewpoints
At the start of the third quarter, there were 10 million job openings in the private sector, and seventy-five percent were in the service sector. The imbalance in the labor markets, especially for service workers, creates a nightmare scenario for the Federal Reserve. That's because as it attempts to slow demand, dampen wage growth, and cool inflation, its monetary tools are much less effective in dealing with the less interest-rate sensitive service sector.
Up to now, the hottest inflation issue was commodities, even excluding food and energy prices. But the composition of the inflation cycle is quickly shifting towards consumer services, making it more difficult to reverse without a dramatic drop in demand due to a prolonged period of higher interest rates.
Core inflation in consumer commodities stands at 6.8%, well off its double-digit highs from earlier than in the year. Yet, prices for core consumer services at 5.6%, the fast annual gain in roughly 25 years, are still accelerating. And core consumer services have nearly three times the weight of core consumer commodities.
Thus, solving the inflation problem requires a fundamental change in service sector growth dynamics. And that cannot occur without a dramatic shift in the demand and price of service sector labor.
Before the pandemic, the private sector service job growth was 1.5 to 2 million per year. So reducing the 7.5 million job openings in the service sector by half would take two years. But that would not mitigate wage pressures, the most significant source of service sector inflation.
The average wages for the private sector non-supervisory service sector workers are up 6.2% in the past year. Excluding the spike in wages in the early months after the pandemic, service sector wages are running at their fastest pace since the early 1980s. And, they are running roughly 100 basis points above the gains in the goods-producing industries.
Private service sector labor and price dynamics are the Fed's most significant hurdles in its inflation fight. Creating slack in the labor market for service workers will require a much official rate and in place for an extended period than it would if inflation was only a goods sector phenomenon.
So Fed Powell's warning that "a lengthy period of very restrictive monetary policy" will be needed to stem the inflation cycle is something investors should not ignore, as it signals a volatile market environment.
Viewpoint commentaries are the opinions of the author and do not reflect the views of Haver Analytics.
Joseph G. Carson
AuthorMore in Author Profile »Joseph G. Carson, Former Director of Global Economic Research, Alliance Bernstein. Joseph G. Carson joined Alliance Bernstein in 2001. He oversaw the Economic Analysis team for Alliance Bernstein Fixed Income and has primary responsibility for the economic and interest-rate analysis of the US. Previously, Carson was chief economist of the Americas for UBS Warburg, where he was primarily responsible for forecasting the US economy and interest rates. From 1996 to 1999, he was chief US economist at Deutsche Bank. While there, Carson was named to the Institutional Investor All-Star Team for Fixed Income and ranked as one of Best Analysts and Economists by The Global Investor Fixed Income Survey. He began his professional career in 1977 as a staff economist for the chief economist’s office in the US Department of Commerce, where he was designated the department’s representative at the Council on Wage and Price Stability during President Carter’s voluntary wage and price guidelines program. In 1979, Carson joined General Motors as an analyst. He held a variety of roles at GM, including chief forecaster for North America and chief analyst in charge of production recommendations for the Truck Group. From 1981 to 1986, Carson served as vice president and senior economist for the Capital Markets Economics Group at Merrill Lynch. In 1986, he joined Chemical Bank; he later became its chief economist. From 1992 to 1996, Carson served as chief economist at Dean Witter, where he sat on the investment-policy and stock-selection committees. He received his BA and MA from Youngstown State University and did his PhD coursework at George Washington University. Honorary Doctorate Degree, Business Administration Youngstown State University 2016. Location: New York.