Editor's Note: Morning Money is a free version of POLITICO Pro Financial Services morning newsletter, which is delivered to our subscribers each morning at 5:15 a.m. The POLITICO Pro platform combines the news you need with tools you can use to take action on the day's biggest stories. Act on the news with POLITICO Pro. The Fed's preferred inflation gauge, the personal consumption expenditures index, is due out this morning and it's expected to be another doozy. But don't sleep on the lesser-known employment cost index, which also comes out this morning and will have increasing importance for the path of Fed policy in 2022 If you read Morning Money religiously, or you're just a Fed nerd, you know that Chair Jay Powell has flagged this somewhat obscure data point as something officials are keeping an eye on as they assess improvements in the labor market. The index, a quarterly report that details total employee compensation and the cost of labor for employers, jumped in the third quarter, and was one factor that prompted central bank officials to pivot toward tighter policy late last year, Powell said. Why does it matter now? So far, Powell has emphasized that inflation has been driven largely by factors relating to the pandemic — stronger demand for goods has collided with supply constraints, pushing up prices. The longer that prices stay elevated, the greater the risk that higher inflation will become embedded in people's expectations. One place that could start showing up is in higher wages. " If that took hold, it would actually be more problematic than the supply chain disruption," said Kathy Bostjancic, chief U.S. financial economist for Oxford Economics. "It would signal perhaps something more permanent, and it would be that wage-price spiral dynamic that Powell and others have talked about." We're not at that stage yet, Bostjancic said, but we're starting to see wage gains broaden beyond workers near the bottom of the income scale. Powell said as much at his December press conference: "Wages have also risen briskly, but, thus far, wage growth has not been a major contributor to the elevated levels of inflation. We are attentive to the risks that persistent real wage growth in excess of productivity [growth] could put upward pressure on inflation," he said then. This week, he repeated nearly the same passage in his opening statement. But he omitted the words, "but, thus far, wage growth has not been a major contributor to the elevated levels of inflation." Why could this become a bigger problem now? Many employers go through salary renegotiations at the start of the year and could feel pressure to lift wages amid persistent inflation. Some businesses that may have raised wages last year but resisted raising prices, in hopes inflation would soon ease, could start to pass that on to consumers. "If real wages rise faster than real productivity, then unit labor costs rise, and then that sets off that dynamic where companies are paying more for workers, and it's starting to eat into their profit margins," Bostjancic said. "One way to offset that is to pass along higher prices to consumers. And that's where you get that virtual reinforcing spiral on the upside." Where are unit labor costs now? Bostjancic looked at the past eight quarters, or two years, to try to smooth out some of the volatility in the data. During that time, they've risen at a 4.9 percent annualized rate, the fastest since the first quarter of 1983. Aren't wage gains a good thing? Yes, but not if they're being eaten up by inflation. That might help explain why consumer sentiment readings — and the president's approval ratings on the economy — are so low, even while workers' paychecks are growing and economic growth is surging. If wages can continue rising while inflation declines, that might turn attitudes around, said Tim Duy, chief U.S. economist at SGH Macro Advisors. "The administration's problem I think is, to the extent that happens, it's not going to be felt in the first half of the year," Duy said. "If it's felt in the second half, does this really work its way into consumer expectations before the mid-terms?" IT'S FRIDAY — Four weeks down, 48 more to go. And just seven until the (official) start of spring. I'm looking at you, New Yorkers and New Englanders. Hope you've got the salt ready and the snowblower gassed up for this weekend's bomb cyclone. Send us your best snow pics, plus tips, ideas, feedback, at kdavidson@politico.com, aweaver@politico.com, or on Twitter @katedavidson or @aubreeeweaver.
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