- Summary: In recent weeks stock market indices have rallied on hopes the Fed will let the federal-funds target rate stand at 5.25% for the remainder of 2006, considering benign wholesale and consumer inflation and continued weakness in the housing market that could easily ripple into the broader economy. But a significant climb in labor costs now has economists worried more rate increases may be on the way: Labor costs jumped 5% in the second quarter compared with the year-earlier period, their fastest rate in six years. The data contributed to yesterday's drop in major stock indexes: The DJIA fell 63.08 points, or 0.6%, the S&P500 lost 12.99, or 1%, and the Nasdaq declined by 37.86, or 1.7%. The Russell 2000 Index, a benchmark of small companies, tumbled 15.46, or 2.1%. Economists questioned whether the pay increases were from one-time items like bonuses, or a broad rise in pay that could lead to rising inflation. Rising labor costs haven't yet forced companies to raise prices according to "beige book" reports released yesterday that found that while there were "widespread increases in the prices of energy and certain other commodities," they "do not appear to have passed through to finished consumer goods." But higher wages can be trouble for the economy if the extra cash starts pushing up prices of other goods, and companies shell out more to their work force to keep pace with inflation. Nonfinancial wages, a labor measure favored by the Fed, rose at a more modest 2.6% pace, showing that while "the trend is still up in terms of unit labor costs, the degree of increase is significantly modified." In it's final month, Q3 is beginning to look glum; the economy is slowing, and labor costs are climbing, and twice as many companies have been giving downward guidance compared with those guiding up. KB Home (NYSE:KBH) said yesterday that orders were down 11% and the housing market was increasingly challenging. Tiffany & Co. (NYSE:TIF) also reported disappointing results last week and guided expectations lower.
- Comment on related stocks/ETFs: The industries hardest hit by rising labor costs are those who are in direct competition with manufacturers in countries where (even before current increases) labor-costs per unit are significantly lower than in the U.S., particularly the auto industry. General Motors Corp. (NYSE:GM) and Ford Motor Co. (NYSE:F) are desperately scrambling to find ways to cut labor costs and keep-up with overseas competitors such as Toyota Motor Corp. (NYSE:TM) and Honda Motor Co. (NYSE:HMC). Whether wage-increases lead to increased consumption (and ultimately more jobs), or whether more consumption leads and employment follows, David Andrew Taylor insists current payroll and labor-unit-cost increases can only be the signs of a strengthening economy. In a related article, WSJ wonders if corporate profits and labor costs can continue to travel in the same direction, and if not, which will give first.
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