Weak GDP, Higher Wage Growth Adds To Fed's Conundrum

It's been a busy few days and I'm just starting to catch up on some stories of importance. On Friday, the Commerce Department released its preliminary estimate of second quarter GDP and it was a rather disappointing result. GDP increased by only 1.2%, less than half of the 2.6% increase that the consensus forecast had predicted. In addition, the first quarter GDP was revised down from 1.1% to 0.8%. Consumer spending was a particular bright spot in the report increasing at an unsustainable rate of 4.2%. The GDP number was reduced by 1.1% due to the reduction in inventories. The usual spin is that this reduction of inventories will be offset by replenishing those stocks later in the year, thereby increasing future GDP. This was a pretty anemic report, especially with the reduction in the first quarter GDP number.

On the other hand, workers are finally seeing some real increase in wages as the latest BLS Employment Cost Index showed an increase of 0.6% in compensation for latest quarter. Inflation adjusted real wage growth is now back to levels last seen before the Great Recession, increasing by 1.3% over the past year. Combined with the increase in hourly earnings seen in the last few unemployment reports and the Atlanta Fed's Wage Growth Tracker, these number indicate that workers wages are finally rising and that the slack in labor demand may finally be diminishing.

June's excellent unemployment report and the Fed's recent statement that the near-term risks to the economy had diminished has put a fall rate hike back in play for the Federal Reserve. These indicators of wage gains will probably also add some pressure to act as well. On the other side, falling interest rates and indicators of low future inflation as well as the pretty poor GDP numbers provide a counter-argument to any rate hike. The employment report at the end of this week will be another number that the Fed and the markets will be watching closely. With few other indicators showing the economy is seriously heating up, it would be nice if the Fed continued to allow wage growth to increase without feeling the need to raise rates. There is no indication that we are entering anything close to the wage-price spiral of the 1970s and workers wages have along way to go before they recoup the losses of the last few years. It would be a real mistake to cut these wage gains off with a rate hike - the workers of the country deserve no less.