Wall Street’s favorite new thing to worry about may already be in the rearview mirror

• Wall Street is worried stronger wage growth will lead the Federal Reserve to raise interest rates more quickly.
• Evidence from the Atlanta Fed’s Wage Growth Tracker suggests the rate of increase in earnings peaked in 2016 and has been declining since.
• David Blanchflower, a former Bank of England member, tells Business Insider the unemployment rate could fall a lot further before generating undue inflation.
• He thinks the Fed should stop raising interest rates now, or risk undermining the recovery.

There’s been a lot of finger-pointing over the catalyst for the stock market correction. Was it the machines? Was it faster-than-expected wage growth? A combination of the two?

Either way, a 2.9% annual rise in average hourly earnings contained in the January jobs report, the largest gain since the recession, certainly caught investors’ attention, injecting volatility into what had been a complacent, gravity-defying stock market.

However, there is reason to believe that, even if the increase goes beyond a statistical anomaly, it may be more of a lagging indicator than a predictor of future economic conditions.

The Federal Reserve Bank of Atlanta publishes a leading indicator called the Wage Growth Tracker. That index peaked at 3.9% in November 2016, and has since been slipping, and is now hovering just above 3%.

“Wages are now growing at the same pace as October 2015,” writes Joseph Lavorgna, chief economist at Natixis, in a research note. “Relative to history, wage and price trends are likely to stay muted.”

At the same time, Lavorgna said, US inflation has fallen short of the Fed’s 2% inflation target for much of the economic expansion. “Therefore, it would be wise for the Powell-led Fed to proceed cautiously in raising interest rates,” adds Lavorgna.

He said a larger-than-expected rise in the January consumer price index, which at first led to a sharp market selloff before things stabilized, does not change that underlying picture.

The Fed’s preferred inflation measure, the personal consumption expenditures index or PCE, “tends to run below the CPI and has undershot its desired 2% target for most of the last seven years.”

Natixis

Ye of little faith

There is something curious about the market’s knee-jerk reaction to higher inflation: investors immediately presume, despite the central bank’s repeated promises and reassurances to the contrary, that Fed officials will likely overreact to any sign of incipient price growth and thereby risk tightening policy too quickly, causing a recession.

The Fed’s own policy statement has long stated policymakers think “economic conditions will evolve in a manner that will warrant further gradual increases in the federal funds rate; the federal funds rate is likely to remain, for some time, below levels that are expected to prevail in the longer run.”

Yet at one of the first signs of solid, constructive wage growth, the market’s had a meltdown. Why the disconnect?

David Blanchflower, a former rate-setter at the Bank of England now at Dartmouth College, sees this as a result of what he sees as a pervasive anti-employment bias among central bankers, which comes in the form of an irrational fear of inflation dating back to the 1970s — when economic conditions, including the bargaining power of labor, were completely different.

“This is all about the fact the Fed thinks the ‘natural’ rate of unemployment is 4.3% to 5%, so with an unemployment rate of 4.1% they are raising rates to increase unemployment,” he told Business Insider. “This of course will lower wage growth.”

The “natural rate” of unemployment, a rather callous economic term, refers to the lowest rate of joblessness that can be achieved without generating a worrisome spike in inflation due to an overheating economy.

For most Fed officials, a 4.1% rate is pretty much at the level they consider “full employment,” if not lower.

Blanchflower isn’t buying it. He thinks the low inflation and weak wage backdrop clearly show the jobless rate could fall substantially further — meaning the Fed has no business raising interest rates at all right now.