The curious case of the missing US inflation

Such low unemployment levels have typically pushed wages higher thus driving inflation also higher.

But this does not seem to be the case today. Instead, the US real average hourly earnings growth rate is an anaemic 1.7%, which lags the economic growth rate of 3.4%².

Fig.1: Inflation remains soft despite record low unemployment¹

So, what is the reason for this missing wage pressure?

Technological progress is one much-discussed potential factor; another is the rise of low-wage employment.

Some suggest that the rapid rise of online retailers, such as Amazon, has exerted a key disinflationary pressure.

Upon closer inspection, however, the impact appears negligible. The ‘Amazon effect’ only narrows the price gap between online and offline retailers³; research has shown such online competition contributed 0.02 percentage point to US inflation⁴.

We can safely exclude the ‘Amazon effect’ from our puzzle, it seems.

That said, it is important not to be overzealous and discard the impact of technology wholesale.

Artificial intelligence, for example, and the Internet of Things⁵ are at the core of the technological revolution. Moreover, automation and robotics have superseded many low-skilled, routine, and administrative jobs.

Technology, therefore, provides more of a direct boost to human productivity and cost savings.

Just look at how ride-hailing apps help match drivers and passengers within minutes, eliminating the jobs of call-centre operators. More professionals can nowadays work from home using internet connections, saving on both commuting time and office expenses.

The problem seems to be that the resulting boost to productivity has not ‘trickled down’ to wage earners.

US output per hour, for example, has increased by 44.8% over the past 20 years, far outpacing the 17.5% growth in real compensation i.e. wages, mostly. See Fig.2.

Fig.2: US output grows faster than compensation⁶

Why has this happened?

One explanation is the waning power of trade unions. In 2018, just 10.5% of wage and salary workers in the US belonged to a union; almost half the rate in 1983. As the collective bargaining power declines, it is now harder for labour to push through wage claims than in the past.

But it is not the only explanation.

As real wage growth has been flat-to-sluggish, it has also been difficult for seniors to not only save for retirement but also live once retired, forcing many to re-enter the workforce.

The majority of these seniors work in part-time, low-skilled jobs, mostly as personal-care and home-health assistants. There were about 2.9 million such jobs in 2016, but this number is projected to increase by around 41% by 2026, making this job category one of the fastest-growing fields in the US⁷.

Unfortunately, these jobs had a median earning of just US$23,100 per year, 38.7% less than the national median of US$37,690 in 2017⁷.

Such labour demographics and dynamics, as a result, have hindered wage growth despite those deceptively low (and attractive) unemployment numbers.

Even Janet Yellen (former Fed Chair) has reportedly admitted⁸ that the record-low unemployment numbers are possibly ‘misleading’ given that the official unemployment definition excludes those ‘discouraged workers’ who have given up the search for work.

The overall result of these different forces can be seen in the widening difference between the jobs on offer and the number of individuals working.

The daunting truth (Fig.3) is that despite rising non-farm payrolls, the labour participation rate has fallen to, and hovered around 62.5% since 2013.

Fig.3: More individuals need more than one job to make a living in the US⁹

In other words, many Americans are being forced to have more than one job to make ends meet, suggesting the upward pressure on wage growth remains minuscule.

As such, inflation expectations should remain low.

This apparent lack of inflationary pressures, coupled with the weakening momentum in the US economy as well as the rising risks to the global outlook, led the Fed to signal a pause in its rate hike intentions in early 2019.

Some observers (as in mid-February), are even expecting no rate hikes in 2019 (see Fig.4).

Fig.4: Little expectation for rate cuts for 2019¹⁰

Against this backdrop, income yielding assets should come back into favour.

The 6.9% interest yield on US high yield bonds¹¹, for example, looks appealing. Refinancing risks are also expected to edge lower alongside with the moderate interest rate outlook.

The impact of ageing demographics and technology is also evident in Asia, helping suppress inflationary pressures.

Coupled with the Fed’s dovish stance, this opens the door for Asian central banks to likewise halt, or even cut, rates.

Asian high yields, currently yielding close to 9.0% and trading with spreads of more than 300 basis points¹², are thus a viable choice for income-seeking investors who have more aggressive risk tolerance (read more).

And as Asian central banks slow rate hikes, the funding costs for Asian real estate investment trusts (REITs) are less of a burden. This should, in turn, be positive for their future dividend distributions (read more).

Investors should fear the inflation bogeyman no longer. It is time to set foot on the steady path of income accumulating strategies.