There are many factors that influence market perceptions about the health of the U.S. economy. Three of the primary indicators that we follow at Gradient Investments are:

• Corporate earnings growth
• Gross domestic product growth (GDP)
• Employment

Of these indicators, employment tends to be the one that hits closest to home for investors and the general population. At its most basic level, jobs provide income through a paycheck, which supports consumer spending and can be a driver of sustained economic growth.    

A lower level of unemployment is typically a positive influence on the economy. Jobs provide individuals with income which they can use for their basic needs, discretionary items and services. When people are working or feel like they could get a new job if needed, they earn money and, in the U.S. especially, have a greater propensity to spend. A strong U.S. consumer is essential to a strong U.S. economy since consumer spending makes up 68% of U.S. GDP.¹

One of the most common ways of measuring the health of employment in the U.S. is the unemployment rate. The chart below reflects the unemployment rate since 2000. The latest unemployment, reported in January for the December rate, was 3.7%.² This level is near the historical lows of 3.4% going back to 2000. This is widely considered to be near full employment and an indicator of a very healthy job market.

As with most indicators, there are both puts and takes. A benefit of low unemployment is the economy is typically robust and consumers are spending money, but some worry that too low an unemployment level can spur higher levels of inflation. In 2022, inflation, measured by the Consumer Price Index (CPI), was increasing rapidly; it peaked at 9.1%³ in June, the largest increase in over 40 years. The Federal Reserve has two mandates: full employment and keeping prices stable. While employment was robust, the rampant rise of inflation caused the Federal Reserve to aggressively raise the fed funds rate to slow the economy to reduce inflation. Since the high in June 2022, inflation has dropped (but remains elevated compared to historical averages) while the level of unemployment remained at historically low levels.

There has been a debate on whether wage inflation will be an impediment to lowering the overall inflation rate to 2%, which is the official target rate for the Federal Reserve. The chart below shows the inflation rate (gray line) compared to wage growth (red line) going back to 2007. The current wage inflation rate is 4.1%,⁴ while the overall level of inflation is 3.1%.⁵ Since 2007, when the Bureau of Labor Statistics (BLS) started to measure wage inflation data, the average is 3% compared to the average inflation rate of 2.5% during the same time frame. While we understand the concern about wage growth spurring inflation, it is our opinion that wages that exceed the level of headline inflation is a good thing for the U.S. economy. Consumers who are receiving pay increases that are higher than the increases in the cost of purchases like food and gas have a greater ability to spend on things they want, rather than only the things they need.

A slightly higher level of wage inflation compared to the CPI is normal, but the more problematic and worrisome situation is when inflation is significantly higher than wage growth, which was the case in 2022 (blue circle/arrow in the chart). When wage increases don’t keep up with overall inflation, consumers tend to pull back on spending which becomes a headwind for the economy.

The health of the economy and direction of markets will be debated (with opinions varying) but most would agree a strong job market is a positive tailwind for economic activity. A low level of unemployment may cause wage inflation to remain above historical averages, but Gradient Investments believes more money in the consumer’s pocket is a good thing and higher wages is a positive attribute of inflation.

1. Consumer Spend as a Share of GDP
2. Bureau of Labor Statistics (BLS) Unemployment Rate
3. BLS June 2022 Inflation Rate
4. BLS and St Louis Fed Wage Growth
5. BLS Consumer Price Index (CPI)