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Wage inflation could keep the Fed engaged.
Bottom Line
Joseph Biden proudly considers himself the most pro-union president in history. This past Tuesday, for example, he stood in solidarity with striking United Auto Workers (UAW) in Detroit—the first Commander-in-Chief to walk a picket line. His mantra has been that record profits for companies should translate into record wages for workers. With a contentious general election only 13 months away, it’s a savvy political strategy that may help him garner millions of additional votes.
But on the other side of this populous coin, generous union wage gains well above the overall inflation rate could keep the Federal Reserve holding interest rates higher for longer. If that results in slower economic growth, declining corporate profits and lower stock prices, the risk of stagflation or recession could increase. Little doubt Biden’s opponents would use that potential turn of events in their own presidential campaigns.
It's all about inflation Inflation peaked last year and is declining. Nominal CPI spiked from 1.4% year-over-year (y/y) in January 2021 to a 41-year high of 9.1% in June 2022, but now sits at 3.7% in August 2023. Headline inflation is falling faster than core inflation—why we believe the Fed is hesitant to declare victory in their tightening cycle.
Witness this morning’s update on the PCE index, the Fed’s preferred measure of inflation. Nominal PCE declined from a 41-year peak of 7.0% last June y/y to 3.5% in August 2023, a decrease of 3.5% over 14 months. Core PCE has declined from a 39-year peak of 5.4% in February 2022 to 3.9% in August 2023, for a drop of 1.5% over 18 months. The Fed’s target remains at 2%, which it forecasts will be achieved by the end of 2026.
Playing catch up Average hourly earnings peaked at 8.1% y/y in April 2020 in the immediate aftermath of the pandemic recession, as employers were trying to entice employees to return to work. Wages have since declined to a 4.3% gain y/y in August 2023, and they have averaged 4.8% y/y since the onset of the pandemic in 2020. But from the beginning of 2007, when the government started to collect the data, hourly earnings grew at an average of 3% annually.
The Job Opening and Labor Turnover Survey (JOLTS) peaked at a record 12 million job openings in March 2022 (two openings for every unemployed worker) but has since declined 27% to 8.8 million available jobs (1.5 job openings per unemployed worker).
Over the past year, labor unions have successfully leveraged this supply/demand imbalance in employment to negotiate long-term contracts and recover ground lost to the worst inflation in four decades. Some prominent examples:
- UPS 35% wage gains over five years for 340,000 employees
- West Coast dock workers 32% over six years and a one-time “hero bonus” for 22,000 workers
- State of Illinois American Federation of State, County and Municipal Employees 19.3% over four years for 35,000 public servants
- Airline pilots:
- Delta 34% over four years for 13,000 pilots
- United Airlines 40% over four years for 16,000 pilots
- American 46% over four years for 15,000 pilots
On strike The UAW launched a targeted strike on September 14, potentially impacting 150,000 workers at General Motors, Ford and Stellantis. The union started the negotiation looking for a 46% wage increase over four years and for a 20% reduction to a 32-hour work week. The Detroit Big Three countered with a 10% raise with no change in the length of the work week.
Other UAW demands include the re-imposition of cost-of-living adjustments and defined-benefit pensions, the restoration of retiree medical benefits and the unionization and comparable wage rates for workers in battery and electric vehicles (EV) assembly plants.
Over the past fortnight, the parties have moved toward the center, with the Big Three doubling their wage offer to 20% and the union reducing its demand to 30%. So a deal may be coming into focus.
Electric vehicles smack in the middle But a large part of the problem is the Biden Administration’s aggressive transition to EVs, including a mandate that they comprise two-thirds of automaker sales by 2032. California, for example, has banned the sale of gas-powered vehicles by 2035. In sharp contrast, electric vehicles comprised only 3% of Detroit’s sales last year. That’s an extraordinarily rapid expansion, at a time when EVs are too expensive for the average consumer, battery technology is primitive, national recharging infrastructure is inadequate and range anxiety is rampant.
EVs can be built with 30% fewer workers than gas-powered vehicles, so the UAW is rightfully concerned about losing a significant number of jobs if Biden’s ramp-up schedule remains in place. Naturally, the union wants job guarantees. But the Big Three are losing gobs of money in their EV transition. Ford loses an estimated $60,000 on every electric vehicle it manufactures. It hopes to use its gas-powered profits to fund the government’s mandated transition. General Motors and Stellantis are investing $35 billion through 2025 and Ford is investing $50 billion through 2026.
Competitive environment eating Big Three’s lunch Tesla has about 60% of the EV market at present, and its non-unionized workforce earns about $45 per hour in wages and benefits. The foreign auto makers (Honda, BMW, Mercedes, etc.) who operate in the right-to-work states in the Southeast U.S. pay their workers about $55 per hour. A UAW member earns about $65 per hour pre-strike, and the Wall Street Journal estimates that their wages would more than double to $150 per hour if all demands are met. Labor costs approximate 5% of the cost of a fully assembled car. The Big Three’s industry-leading global market share, 71% in 1998 and 47% in 2008, has shrunk to 40%.
Potential economic impact There’s little question the UAW and the Big Three will negotiate a compromise. But if the companies pass the wage increases onto their end customers in the form of higher prices, then inflation will rise, which will likely keep the Fed mired in its higher-for-longer mindset. The Big Three have been stocking inventory this year, which may last into Thanksgiving before the situation gets dire. But if the companies attempt to absorb the wage and benefit increases to protect their declining global market share, then profit margins, corporate earnings and share prices likely will decline. The combination of these factors could result in economic stagflation: rising inflation, slower economic growth and an elevated risk of recession.