Q1 ECI delivers another setback for the Fed's inflation fight

Summary

The Q1 reading for the Employment Cost Index (ECI) was yet another data point suggesting that progress on inflation is stalling out. The ECI is the Fed's preferred measure of labor cost growth, and the 1.2% quarter-over-quarter increase was stronger than consensus expectations for a 1.0% gain. An equally-high reading one year ago kept the year-over-year gain stuck at 4.2%. Seasonal factors may not quite be fully capturing the wage and benefits dynamics at the start of the year, but otherwise the details were not suggestive of many one-off quirks. Private sector employment costs jumped sequentially, and excluding sometimes volatile incentive paid occupations did nothing to dampen the gain.

On balance, today's ECI reading is not the end of the world for the FOMC, but it is yet another data point that suggests the inflation slowdown that began this time last year stalled out in the first quarter of 2024. We expect the FOMC to hold the federal funds rate steady at its next few meetings, leaving plenty of time to ascertain whether the Q1 data is a bump in the road or a canary in the coal mine. Signs of faltering labor demand, declining labor market turnover and still solid labor supply suggest to us that employment costs will decelerate further as the year progresses. But, it will take time to see that in the data, and this is why we think the FOMC will keep rates unchanged through at least the summer.

Broad pickup in Q1 employment costs keeps work cut out for Fed

The first quarter Employment Cost Index (ECI) delivered another setback in the Fed's fight against inflation. The ECI capped off a quarter of price growth coming in stronger than expected, with labor costs over the quarter advancing 1.2% versus consensus expectations for a 1.0% gain. On a year-ago basis, compensation costs are up 4.2%, an improvement from this time last year (4.8%) but unchanged from Q4 in the latest sign progress, in lowering inflation stalled early this year (chart).

The pickup in Q1, from a 0.9% increase in Q4, is particularly disappointing given that the ECI tends to offer the cleanest and most encompassing read on labor costs and thus is the Fed's preferred gauge of inflationary pressures from the labor market. Unlike the more timely average hourly series from the monthly employment report, the ECI controls for compositional shifts in the economy's jobs and includes compensation growth for public sector workers. It also includes the cost of employee benefits, which account for about one-third of compensation.

Download The Full Economic Indicator