Catch-22

Shortly after the Tax Cuts and Jobs Act was passed on November 2, 2017, there was a lot of optimism that businesses would spread the wealth by sharing their tax-cut windfall with their employees.  Every day for a couple of weeks, it seemed, another major corporation would announce plans to pay bonuses or otherwise boost employee benefits.  We pointed out at the time that very few of these announcements included plans for permanent wage increases.  Rather, nearly all were one-off bonuses done largely as a goodwill gesture to thank the Trump administration for the tax relief.   We weren’t judging or critiquing corporate America, but we understood that businesses rarely do things out of the goodness of managements’ hearts.  Decisions are made on behalf of shareholders, and we didn’t believe corporate management teams would advocate for higher wages absent a shortage of labor or a strong boost in demand for their products in services (or both).  In our January 3rd Market Commentary, we wrote the following:
“Some believe that lower corporate tax rates will, in short order, lead to more job growth and rapidly rising wages. We are not in that camp. We do believe that some minor portion of the corporate tax-cut windfall will find its way to workers over the near term. However, employers are not simply going to increase payrolls and raise wages simply because they receive a tax windfall. Remember, companies have been generating record profits and cash flow in recent years, yet they have instead used the profits to buy back stock, raise dividends and make acquisitions. The tax changes do not really change that calculus.”
Since that time, we’ve read countless articles about how the corporate tax cuts have led to even higher levels of stock buybacks and dividend increases.  There was also an article in The Wall Street Journal yesterday entitled, “Tax Cuts Provide Limited Boost to Workers’ Wages.”  This article contained results from several recent surveys about the use of tax-cut windfalls by corporate America.  The following are some quotes from that article:
“A new survey of 152 companies by executive-recruitment firm Korn Ferry International revealed 14% were putting part of their tax-cut savings into base salary increases.”
“A poll of 1,500 companies by consulting firm Mercer LLC showed 4% are redirecting tax savings to budgets for bigger paychecks in the coming year.”
“And in a survey of more than 1,000 companies published by human-resources consulting firm Aon PLC, 99% said the tax cuts weren’t prompting them to increase minimum wages.”
“The nonprofit (Just Capital) calculates that the companies it is tracking will save a combined $59.3 billion from the tax overhaul. Of that amount, 7%, or $4.2 billion, appears to be destined for workers in the form of bonuses, benefits, wage increases, training or retirement contributions. The rest is being used for things like share buybacks, philanthropy and job creation.”
Now, it is true that wage growth has been accelerating a bit.  The most recent data covering the month of August put the year-over-year increase in Average Hourly Earnings (AHE) at +2.9% – the highest level since 2009.  Unfortunately, inflation (as measured by the CPI) has been increasing at a much faster clip having risen from negative readings in early 2015 to +2.7% in August.  Therefore, recent increases in wages have barely been enough to cover the increases in the cost of living, leaving workers no better off.
Tomorrow is a big day for economic data.  The Department of Labor’s jobs report for September will tell us how many jobs were created during the month and what the unemployment rate was.  But the more important data point by far will be Average Hourly Earnings for September.  The consensus expectation is that AHE grew 2.8% to about $27.25.  One would think that a higher number would be good news, and they wouldn’t necessary be wrong.  However, if the number does come in hotter than expected, there will be further concerns that inflation is picking up.  Improved economic growth and rising inflation have already pushed interest-rates up to multi-year highs.  The increase in interest rates is finally causing some stock-market volatility today.  If we do get a better-than-expected number for AHE tomorrow, it might cause the Fed to become incrementally more inclined to hike interest rates more aggressively.  At some point, and maybe quite soon, these higher interest rates are going to become a problem.
This is the catch-22 that the Fed has put itself into.  Just as we are finally beginning to see stronger wage growth, which has been the missing piece in this economic recovery, the Fed is likely to take the punch bowl away by hiking interest rates.   Too many rate hikes and we could find ourselves in another recession.  So should we be hoping for weaker-than-expected wage growth then?  See what I mean?