Is ECI data good new for the FOMC?

The Employment Cost Index report released on Tuesday had an unusual impact across almost all financial markets, particularly the US dollar that weakened following the index reading.

Analysts pointed out that the reading is one more inflation-linked indicator that is seen as easing. While the report supports inflation moving back toward the 2% target, labour cost growth is still too strong to be consistent with it staying there for the long haul. More slowing will be needed before the FOMC feels comfortable declaring victory over inflation. It is worth noting that ECI slowed for a third consecutive quarter

Moreover, the ECI report offers the FOMC one of its cleanest looks at how a tight labour market is translating into elevated wage pressures. Before the pandemic, employment cost growth was running at just shy of a 3% pace alongside core PCE inflation that was similarly just below 2%. The 5.1% increase in the ECI over the past year and 4.0% annualized increase in Q4 suggest that labour costs are still growing about a percentage point above what would be consistent with the FOMC’s 2% inflation target given trend-like productivity growth.

When it comes to inflation, easing labour cost growth should not be conflated with benign labour cost growth. The labour market remains incredibly tight. Plenty of household-name companies have announced layoffs over the past few months, but initial jobless claims continue to hover near record lows, and more independent businesses report having a hard time to filling jobs than at any point before COVID.

Therefore, while the deceleration in labour costs is a welcome development from the Fed’s perspective and further sign that inflation is headed back toward 2%, it is too soon to declare that it will stay there for the long-haul.