We have written often of late about real interest rates – which are typically arrived at by adjusting a benchmark rate such as the Fed Funds Rate for the rate of inflation, measured, for example, by the Consumer Price Index. Specifically, real rates are positive when the benchmark rate is above the rate of inflation and negative when the benchmark rate is below the rate of inflation. Economic history tells us that positive real interest rates act as a brake on borrowing, spending, and growth while negative real rates act as an accelerator for borrowing, spending, and growth.
Today, real rates are deeply negative – and supportive of growth – with the Fed Funds Rate at 0% and the CPI running above 6%. It isn’t just interest rates that can be adjusted for inflation, but wages, or at least wage gains, which are arrived at by comparing month-on-month or year-on-year changes in wages to changes in the rate of inflation. If wage gains are outpacing inflation, real wage gains are positive and if wage gains are trailing inflation, they are negative. While negative real rates are widely considered a positive for the economy, negative real wage gains are not, as income growth is not keeping up with the increase in the cost of living (if your wages go up by 2% and inflation goes up by 3%, you are, all things being equal, losing ground financially).
For most of the past year, wage gains have trailed inflation (see graph), which is likely why consumer sentiment surveys have turned lower of late. For the wage dynamic to improve, one of two things must happen: wages need to increase even faster than they have of late, or inflation must come in. The tricky thing about the former fix is that meaningful and ongoing wage increases can feed an inflationary spiral that could prove very harmful to the economy and very hard to arrest. Hopefully, the Fed will be successful in slowing the rate of inflation in 2022, allowing the American worker to “keep” more of what they are making.
The views expressed are those of Brinker Capital and are not intended as investment advice or recommendation. For informational purposes only. Brinker Capital Investments, LLC, a registered investment advisor. 3140-BCI-12/20/21