- - Thursday, April 7, 2011


This past week could be characterized as a relatively quiet one in the market — trading volumes were somewhat light, new economic data flow was modest and corporate earnings news was light in advance of next week, which kicks off March 2010 earnings results. Despite that, two key issues came to the forefront — inflation and the risk of a federal government shutdown.

With the clock still ticking on the latter, let’s tackle inflation and what is going on with wage growth, or the lack thereof.

Given the steady rise in what people have been spending at the grocery store, at the gas pump and soon elsewhere, inflation is not a new concern but rather one that is more and more on the minds of people and companies alike.

A number of companies already have announced price increases to offset rising costs — FedEx and UPS, Starbucks, Nike, Polo Ralph Lauren, the Hershey Co., Cheesecake Factory, Applebee’s and Red Robin Gourmet Burgers to name a few. Others, including Chipotle Mexican Grill and Domino’s Pizza, have announced they are taking a wait-and-see approach to gauge how customers meet competitors’ price increases before making a decision on prices.

With inflation pressures continuing to mount, consumers are starting to feel the pinch, which in turn is driving down consumer confidence. Last week, the Conference Board reported that consumer confidence readings fell from 72.0 in February to 63.4 in March, missing expectations for the month. That decline reversed five straight months of improvement and raises concern about shoppers’ ability and willingness to spend in coming months as expectations about income gains sour.

A central point to this is the lack of wage growth, despite the rebound in jobs. According to Labor Department data, the average workweek didn’t get any longer and hourly wage rates have been flat for the past several months. At the same time, comparing and contrasting other data supplied by the government shows that real disposable income, or disposable income adjusted for inflation, was negative in February, marking the first drop since September. Taking a look back over the past 12 months, average hourly earnings have risen by 1.7 percent, but prices have gone up 2.2 percent, according to the Consumer Price Index. Simply stated, this means that real wage growth has not been keeping up.

Despite recent job growth, there is ample slack in the labor pool, which makes it an employer-friendly environment in terms of wages. In other words, far more job growth is needed to tighten the available labor pool and drive wage increases. Should inflation- adjusted disposable income remain negative or continue to lag inflation, consumers and their spending are likely to retreat. With consumer spending accounting for two-thirds of the economy, any hiccup would impede the burgeoning recovery.

What I find intriguing is the view on inflation from the Federal Reserve. In the minutes from the March 15 Federal Open Market Committee meeting we find the Fed’s recent view: “Recent increases in the prices of energy and other commodities are currently putting upward pressure on inflation. The Committee expects these effects to be transitory, but it will pay close attention to the evolution of inflation and inflation expectations.”

Pay attention?

It’s an interesting choice of words, but let’s remember that the core Consumer Price Index excludes volatile components such as food and energy. By comparison, data from the Labor Department show that 12 percent of consumers’ annual expenditures goes for gasoline, motor oil, fuels, utilities and public services and another 12.4 percent is for food, either at home or away from home.

Much like you, I wonder how the Fed and other entities omit what amounts to nearly 25 percent of consumers’ average annual expenditures when examining inflationary pressures.

Clearly I am not alone.

Jeffrey Lacker, president of the Richmond Federal Reserve Bank, and Charles Plosser, president of the Philadelphia Federal Reserve Bank, recently shared views that the Fed may need to alter monetary policy rather than risk greater inflation and economic instability in the future.

These two gentlemen are not alone in their thinking as fed-funds futures point to rising expectations for a rate increase toward year’s end and into 2012.

Two logical questions would be: By how much would interest rates rise, and is that too late? There is a fine line between fighting inflation and crimping the burgeoning domestic economic recovery. In terms of timing, China’s Central Bank raised its interest rates this week for the fourth time since October, and the European Central Bank raised interest rates by 25 basis points to 1.25 percent Thursday. This is the European bank’s first increase since July 2008, and its intent is to counter firming inflation pressures in the 17-country eurozone.

Stay tuned.

Chris Versace, the Thematic Investor, is director of research at Think 20/20, an independent equity-research and corporate-access firm in the Washington, D.C., area. He can be reached at [email protected] At the time of publication, Mr. Versace had no positions in companies mentioned; however, positions can change.

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