Why doesn't the Federal Reserve loosen its stance? Wage inflation has quietly arrived.

Since the beginning of this year, the phenomenon of "greedy inflation" caused by significant price increases by companies is disappearing. However, another alarming situation is preventing the Federal Reserve from ending the rate hike process: the growth rate of wages has already exceeded the growth rate of prices.

In the first quarter of 2023, the proportion of wages and salaries in the value added by enterprises in the United States rose to 49.3%, higher than the level in 2019. As of the first quarter, the labor cost per unit of sales increased by 6%, surpassing the price increase of 5.3% during the same period, while the profit growth of per unit of output only increased by 1.6%.

Although this may not cause as much public anger as significant price increases by companies, it is still a problem for reducing inflation. Federal Reserve Chairman Powell has previously emphasized the need to pay attention to the labor market, especially whether wage growth will bring the risk of "wage-inflation spiral."

In addition, more and more American workers, including the International Brotherhood of Teamsters, the United Auto Workers, and airline pilots, are demanding significant pay raises due to labor shortages and corporate profit growth. This poses a more challenging task for the Federal Reserve, which is striving to combat inflation.

According to the CME FedWatch Tool, there is an 89% probability of a 25 basis point rate hike in July and a 20% probability of another 25 basis point rate hike in September.

The minutes of the Fed's June meeting, released earlier, showed that participants who supported a 25 basis point rate hike pointed out that "the labor market remains very tight, economic activity is stronger than previously expected, and there are hardly any clear signs that inflation will return to the Federal Open Market Committee's 2% target over time."

In addition, rising labor costs, gradual improvement in supply, and weak demand will impact corporate profits.

According to revised government data released last week, the pre-tax profit margin of US companies in the first quarter of 2023 has roughly returned to pre-pandemic levels. Corporate profits had expanded significantly in 2021 and 2022, when costs soared and companies passed the pressure onto consumers in response to significant price increases.

Data from FactSet shows that out of the 11 sectors in the S&P 500 index, 6 sectors had lower profit margins in the second quarter compared to four years ago.