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Welcome back. One day I will stop writing about inflation, but today is not that day. Perhaps inflation is just the name I give to all my economic anxieties now? If you have other, better fears to share, send them along: Robert.Armstrong@ft.com.
Also, I’m taking tomorrow off. See you Wednesday.
The sin of wages
Last week I wrote about my exchange with the economist Olivier Blanchard, who is worried about inflation, and he gave some stern advice: “Watch new wage contracts and wages like a hawk.”
Friday’s employment report provided some hawk food. Nonsupervisory workers’ wages rose by 0.55 per cent between April and May, an annualised rate of just under 7 per cent. That’s high.
The growth rate of wages has been extremely volatile since the huge spike in the spring of 2020, when so many low-wage workers lost their jobs. But this is the second consecutive big month and, as we journalists like to say with only a little irony, two makes a trend. Data from the Fed:
The economic punditocracy was impressed. Here’s Rick Rieder, BlackRock’s fixed income CIO:
“Average hourly earnings data of the past couple of months . . . has depicted a very tight labor market and a heightened need to increase wages to bring people into the workforce”
That sounds like just the kind of thing Blanchard cautioned about — workers with negotiation power “ask[ing] for and obtain[ing] wage increases” creating inflationary momentum. Rieder also provided this striking chart of survey data from the National Federation of Independent Business. Half of firms say they need workers they can’t get:
Paul Ashworth, chief North America economist at Capital Economics, points out that the May wage data may actually understate wage pressure:
“The return of lower paid restaurant workers should be weighing on that average, so that 0.5% m/m is even stronger than it looks and suggests that the increasingly acute labour shortages are translating into rapid wage growth.”
Time to panic? I do love a good panic. But the market did not panic at all, apparently focusing on the relatively cool increase in job growth rather than the hot increase in wages (cool data = Fed stays easy = asset prices go up). Stocks rose nicely Friday after the data came out and Treasury yields fell.
As much as I love to hyperventilate, I hate declaring, without an excellent reason, that the market has it all wrong.
One explanation for the sanguine market response is that, as several readers have emailed me to point out, the link between wage data and future inflation cannot be taken for granted. James Athey, a fixed income portfolio manager at Aberdeen Standard, got in touch to argue that the US economy’s competitiveness is so degraded, with many local markets dominated by just a few employers or “labor monopsonies,” that workers’ leverage in wage negotiations is likely to be fleeting.
Athey also noted that the wage data isn’t very good quality. It’s basically one huge number (all the income) divided into another (all the workers). It glosses over everything about the composition of the workforce, and in particular the fact that unskilled labourers are a growing part of it.
Other readers argue that the empirical data linking wage increases in future inflation are weaker than commonly imagined. Dimitris Valatsas, chief economist at Greenmantle, pointed me towards this review of the literature from the San Francisco Fed, which concludes:
“Researchers have extensively studied how wage data might help predict future price inflation. The overall conclusion of the literature is that wages generally provide less valuable insight into future prices than some other indicators. In fact, models that do not incorporate wages often result in superior inflation forecasts.”
Here, by the way, is the long-term wage growth/core CPI growth chart. The two are clearly linked (the correlation coefficient is .76, Excel tells me), but if there is a clear pattern of wages leading inflation, I’m struggling to see it:
I put these objections to Blanchard. He acknowledged the debate in the literature, but said that “I find totally implausible the notion that firms would not react to costs, and the largest cost is typically the wage bill.” As for the composition of the workforce, he replied that for the purposes of forecasting inflation, “what matters is the wage relative to productivity. Composition of employment does not matter. If we employ more low skilled workers, they are paid less but their productivity is lower.”
There is a lot of disagreement about inflation.
The last mystery of the pandemic: office real estate
Here is a very interesting chart (from Refinitiv):
That is the performance, since the pandemic first began, of three of the largest real estate investment trusts that invest primarily in city-centre office buildings. I think the chart is interesting because, in my estimation, we have very little idea what is going to happen to demand for office space when the pandemic is really and truly over.
Will demand be as strong as ever? Will we need 10 per cent less office space, as more workers work from home at least some of the time? Or will it be more like 20 per cent less? Even less than that? I would absolutely hate to bet money on this.
On the evidence of the office reits, the market seems to be betting that cash flows from office properties will be, oh, 10 or 20 per cent lower than before the pandemic (but that loss estimate has been getting steadily lower). Maybe that is a good guess?
The reason we have very little idea about this is that nobody wants to sell a building, or buy one, or foreclose on one, or have a fight about the rent for one, until the situation gets a little clearer.
“No one is being forced to take a loss right now” says Jim Costello, a senior vice-president at RCA, a real estate analytics firm. “If I’m a creditor and foreclose on a property I’m guaranteed to take a loss, where if I cure it a bit, there is a chance I come though profitably.”
The future of the office “is now the number one topic in our industry,” a senior real estate banker told me last week.
“We don’t know what the implications [of the pandemic] for demand for space. On the one hand, if the amount of space per square foot per person goes up [for health reasons], that’s positive. But if you have fewer people in the office, using fewer desks . . . so far we have not seen major defaults, yet vacancies have climbed. But cash flows have remained strong. The big question is what happens when leases roll over, and that will take time.”
How worrisome is this for the industry? Here is a recent investor presentation slide from Boston Properties. You can just smell the fear pouring off of it:
Our clients just love their offices! They really do! They tell us so all the time! Oh dear.
On the other hand, Jordan Roeschlaub, co-head of debt and structured finance at the real estate advisory Newmark, provides one excellent reason for optimism about office building values, one readers of this newsletter will find familiar. There is a lot of money out there looking for a home.
“There is a boatload of capital that has been raised to be allocated to the real estate space. When transactions come to market, that has to have an effect. [Investors] have to put that money to work, and they have to make up for lost time, because transactions haven’t been done during the pandemic.”
One good read
This excellent business story, about American rugs, got lost in the Sunday New York Times and somehow ended up in the style section. The history of the textile industry in the US is fascinating. I’m hoping it can make a comeback in the post-covid age of reshoring, and that mill jobs might one day return to Eden, North Carolina.