The labor market will help the Fed’s fight against inflation

By Conor Sen

The labor market is proving a new source of optimism in the Fed’s fight against inflation. The labor shortage that drove wages up during the coronavirus pandemic and the economic restart is waning. This may not amount to a labor surplus, but at least we have new areas of steady employment in some industries.

While the overall labor market remains strong, it also now appears that workers’ compensation in some industries may have exceeded fundamentals. This leads to a growing prospect that wage growth for some jobs will stagnate for some time. This is not good news for those employed in warehouses or hospitality businesses, but it offers more hope that the high inflation the country has experienced over the past 18 months will normalize quickly.

Amazon, as I’ve written before, continues to be a good reflection of the country’s labor market dynamics. In its quest to meet its growth goals, Amazon has embarked on a hiring spree in 2021 that has driven up wages not only in the warehouse industry, but also in related industries such as transportation, with employers competing for similar workers. Because Amazon is such a large employer, it almost single-handedly pushed average hourly earnings up nearly 17% in 2021 for warehouse workers.

Then, in late April, the company said it was being overstaffed as American spending began to shift from goods back to services, in a sign that wages for warehouse workers would slow. We now have data on wages for warehouse workers up to May: year-to-date wages in the sector are essentially unchanged from December in nominal terms and deeply negative in real terms that take inflation into account.

This has not led to net layoffs in the industry – warehouse employment increased by more than 100,000 workers in 2022 – it’s just that the wage growth we had in 2021 seems to have been too high. So the rebalancing we have in 2022 is continued employment growth, but with wages falling in real terms until we reach some kind of new equilibrium.

Something similar seems to be happening in the leisure and hospitality industry. Wage growth shot up in 2021, reaching 16.6%, but slowed markedly in 2022. In June, wages in the industry grew at an annual rate of just 2.7%, below the rate of inflation and signaling that the industry has fill the staffing gap after a frantic year of hiring. Meanwhile, employment in leisure and hospitality increased by 550,000 in 2022, suggesting that here too the adjustment is playing out as continued employment growth with real wages falling.

The housing industry could have a turn. In a series of tweets about the state of the housing market in various metropolitan areas, Rick Palacios Jr. of John Burns Real Estate Consulting noted that builders in several metros expect labor costs to ease in the coming months as the market adjusts to the slowing pace of activity.

We have already seen price restraint in other sectors of the economy that have contributed to higher inflation, such as used vehicles and commodity prices. But the concern was that the overheating labor market would be the most difficult area to contain without causing a recession. Some analysts feared that wage growth would find its own pace, like a raging fire, and the only way to slow it would be to pour water on it, a recession.

At least for some of the industries that saw the fastest wage growth last year, that no longer appears to be the case. As leisure and warehouse staffing has met demand, wage growth has stalled. This may be a short-term trend, but it’s worth keeping in mind.

It is important to remember that nothing in this pandemic economic cycle has been typical, including the labor market. Double-digit wage growth for restaurant and warehouse workers in 2021 was not normal, and stagnant wage growth is not expected to continue, either, when the unemployment rate is 3.6%.

We can take this as yet another piece of evidence that inflation can indeed normalize with a little help from monetary policy. As various parts of the economy find post-pandemic normalcy, the chances of avoiding the worst-case economic scenarios people worry about are increasing.