Americans' pay gains rose faster than expected so far in 2024, a cause for concern for the Fed

WASHINGTON -- It wasn't just inflation starting off 2024 hot, paychecks did as well.

A closely watched measure of labor costs showed that compensation growth accelerated much faster than expected during the first three months of the year, providing an unwelcome data point for Federal Reserve officials looking for inflation pressures to ease.

The Employment Cost Index (ECI) rose a seasonally adjusted 1.2% last quarter, faster growth than the 0.9% increase the prior quarter, according to Bureau of Labor Statistics data released Tuesday.

"This isn't going to calm any nerves at the Fed," Scott Anderson, chief economist at BMO Capital Markets, told CNN in an interview.

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Fed officials are closely monitoring the trajectory of wage gains, as there's a concern that accelerated compensation growth may serve as an inflation pressure.

Higher benefits costs helped drive the index to its biggest quarterly increase in a year: Those shot up to 1.1% from a 0.7% gain the prior quarter, while wage and salary growth was unchanged at 1.1%.

On an annual basis, the index that measures changes in wages and benefits held pat at 4.2% for the year ending in March. The heftiest pay gains are occurring in the public sector, where workers are seeing compensation grow 4.8% for the 12 months ended in March.

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Adjusting for inflation, wages and benefits were up a mere 0.8% annually, ticking down slightly from a 0.9% gain.

Economists had expected quarterly growth to come in at 0.9% and for annual gains to slow to 4%, according to FactSet consensus estimates. US stocks fell on the news, with Dow futures down by around 185 points, or 0.5%, in premarket trading Tuesday. Futures were lower by 0.43% on the S&P 500 and 0.46% on the Nasdaq Composite.

Still too hot for the Fed's liking

The Fed favors the ECI over other wage trackers, because it provides a more comprehensive measurement of compensation and includes not just wages but also the costs of benefits provided to workers. The index also includes controls for changes in the composition of employment, essentially measuring wage costs for the same jobs over time.

Worker compensation spiked during the nation's economic recovery from the pandemic as consumer demand outstripped the supply of available workers.

Annual labor cost gains topped out at 5.1% in the second quarter of 2022, a time when inflation rocketed to 40-year highs. Wage gains have since slowed but still remain above historical averages (running in the range of 2% to 3% pre-pandemic) and also above what the Fed wants to see: Central bank officials have indicated that a pace of 3.5% is more consistent with their target of 2% inflation.

The Fed is holding its latest policymaking meeting this week and expected to announce Wednesday that interest rates will remain unchanged. Given the batch of hotter-than-expected inflation data to start the year - and, now, higher-than-anticipated wage gains - economists aren't expecting a Fed rate cut in the near future.

"The Fed would now need to see a spectacular rollover in payrolls in May and June and equally spectacular inflation numbers in order to cut rates in June," Ian Shepherdson, chief economist for Pantheon Macroeconomics, wrote in a note issued Tuesday. "That's possible but the ECI has raised the bar for easing to the point where we now have to look for the first move in September instead."

When good news is bad news

While inflation, and now wages, are moving in the opposite direction of what the Fed wants to see; Tuesday's ECI report is yet another reminder of the pure stamina of the US labor market.

"This is really good news for the economy overall and for the resilience and strength of economic growth," Anderson said. "This will keep real wage growth in the plus column for many workers and will put a floor under consumer spending and keep consumer spending resilient over the next several quarters at least."

A fresh batch of US labor market data will land this week, including the all-important monthly jobs report on Friday. Economists are expecting that the US economy added 230,000 positions, according to FactSet.

While some of the biggest monthly gains have been in large industries such as health care, leisure and hospitality, and government, the job growth has remained broad-based and layoffs have remained low.

The strength in the labor market and still-high (albeit slowing) wage growth have helped workers see real pay gains and continue their economy-powering spending.

But while inflation hasn't stopped consumers from spending, Americans aren't fans of having to put up with three-plus years of higher-than-typical price hikes.

A separate report released Tuesday by the Conference Board showed that consumer confidence retreated in April as it was dampened by elevated food and gas prices as well as concerns about the labor market taking a turn for the worse.

The Conference Board's consumer confidence index fell to a reading of 97.0 in April from a downwardly revised 103.1 the month before and landed at its lowest level since July 2022.