Your Paycheck May Help You Read Fed's Mind on Rate Hike

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By Carleton English

NEW YORK -- As the market examined new job data for July on Friday, analysts at investment bank Goldman Sachs (GS) focused more on wage growth.

And basically, it has stalled, even though unemployment has fallen to about 5 percent from a high of 10 percent during the financial crisis, Goldman said in a report. Not only was growth lackluster through June, salaries have largely been flat since the late 1970s, according to data pulled from Pew Research.

July did little to change that: Wages grew a modest 0.2 percent from the month before, the Labor Department reported Friday. Hiring was largely in line with analysts' estimates, with 215,000 jobs added, while the unemployment rate was flat at 5.3 percent.

Those two data points may be good omens for wages, whose lackluster performance is shown in the graph below, Goldman Sachs says.

"Each incremental decline in labor-market slack should have a larger positive effect on wage growth as the economy gets closer to full employment, which we would expect in the first half of 2016," analyst Kris Dawsey wrote in the report.

Stagnant wages have been particularly troubling for Federal Reserve chair Janet Yellen, even though the Fed's dual mandate is focused specifically on employment and inflation. The rate of wage gains can can be an indicator of underlying economic challenges, including what the Fed terms "slack," or the gap between current performance level and potential.

A large number of underemployed workers or discouraged workers who have stopped seeking work would indicate a large amount of slack in the economy which could push wages down. As underemployed and discouraged workers don't figure into the headline unemployment number, it's possible for an unemployment rate to make the economy look stronger than it is. Indeed, Friday's report said the rate that accounts for discouraged workers is 10.4 percent, significantly higher than the overall unemployment figure.

"The relationship between wage and price inflation is tenuous at best in the short term," Dawsey wrote. "However, we think that Fed officials view wage growth as a useful cross-check on the amount of slack remaining in the labor market, which is difficult to observe directly. In the past, we demonstrated that focusing on wage growth could help the Fed better meet its objectives in terms of inflation and unemployment over time."
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