Wages are the key to Fed policy

If you want to know when interest rates are going to rise, don’t scrutinize the unemployment or inflation statistics; watch what is happening to wages.

To be sure, the Federal Reserve’s mandate has historically been to achieve the lowest jobless rate consistent with stable prices. This would suggest that the jobless rate and the rate of inflation would be the data to keep your eye on.

You may recall that I referred to these two stats a couple of weeks ago, in my column discussing the misery index. When added together, they stand at a 56-year low. This means people are very happy with their current economic state of affairs.

But happiness tells the Fed little about future inflation, and thus, what policy levers it needs to pull. To determine this, the money mavens feel they need a better measure of developing price pressures. Wages appear to be the stat they are focusing their attention on.

In her public statements, Fed chair Janet Yellen has mentioned wages. Evidently, she feels that it is a good indicator of future inflation. The theory here is that when wages rise, it is a sign that economic growth is strengthening enough to increase the demand for workers and thus how much they earn.

As workers earn more, they will spend more. This increase in demand will allow merchants to boost their selling prices to make up for rising costs. So while the Fed can’t control wages, it can influence the economy’s rate of growth with monetary policy.

Thus it would appear that the Fed views wages as the bottom line. It will look to see if increases in employment and in prices translate into wage gains. If they do, the Fed will act; if they don’t, it will wait.

At any rate, inflation and unemployment are not the most accurate data that the government’s statisticians churn out.

For example, there are several measures of inflation. Some measure the changes in a fixed basket of goods and services. This does not take into account changes in buying patterns in response to changes in relative prices. Other metrics do this by changing the weights assigned to each item in the index as people adjust their outlays.

Market Watch

This article is for general information purposes only. It is not investment advice or a solution to buy or sell securities. Opinions are the authors; not necessarily that of OANDA Corporation or any of its affiliates, subsidiaries, officers or directors. Leveraged trading is high risk and not suitable for all. You could lose all of your deposited funds.

Craig Erlam

Craig Erlam

Senior Market Analyst - UK & EMEA at OANDA
Based in London, Craig Erlam joined OANDA in 2015 as a market analyst. With many years of experience as a financial market analyst and trader, he focuses on both fundamental and technical analysis while producing macroeconomic commentary. His views have been published in the Financial Times, Reuters, The Telegraph and the International Business Times, and he also appears as a regular guest commentator on the BBC, Bloomberg TV, FOX Business and SKY News. Craig holds a full membership to the Society of Technical Analysts and is recognised as a Certified Financial Technician by the International Federation of Technical Analysts.
Craig Erlam