Good News: Labor Costs Are Falling

Dr. Jeffrey Roach | Chief Economist

Last Updated:

Key Takeaways

  • Investors are preoccupied with the timing of the first Federal Reserve (Fed) rate cut, but they should also focus on the path of interest rates throughout the full year. 
  • Services inflation is one of the stickier components of inflation and is causing most of the consternation within capital markets. 
  • Labor costs in services-providing industries eased in 2023, foreshadowing improvement in sectors where labor is the biggest corporate cost. 

Updated Rate Cut Expectations

The stickiness of services inflation will likely push out the first rate cut. We’ve always thought the markets were overly zealous in thinking the Fed would cut six or seven times this year. The Fed communicated three cuts; we expect the true number will be somewhere between what the Fed said and what markets are expecting. Historically, the Fed hardly ever does what they say, as can be shown that dot plots are poor predictors of future Fed policy. 

The first rate cut will now probably come in June, unless something drastic happens domestically or abroad. Labor markets are stable, consumers keep spending, and geopolitical tensions are managed enough for the Fed to have lingering concerns about price stability. 

After the Fed’s embarrassing mistake of keeping rates too low for too long and capital markets still reeling from the effects of that mistake, the Fed will not be inclined to make a similar misstep of cutting rates too soon. 

Easing Labor Costs Mean Lower Services Inflation 

The latest data from the Employment Cost Index (ECI) shows that compensation is easing for those in the services-providing industries. This likely foreshadows lower inflation in the services sectors. Now, of course, it takes some time for firms to adjust retail prices after a change in compensation. But nonetheless, the decelerating cost of labor means investors should notice some easing in the sticky components of inflation.  

Easing Labor Costs Will Dampen Services Inflation This Year

Line graph depicting compensation easing in the service-providing industries versus Consumer Price Index from 2005–2024 as described in preceding paragraph.

Source: LPL Research, Bureau of Labor Statistics/Haver Analytics 03/13/24
Disclosures: Past performance is no guarantee of future results. Indexes are unmanaged and cannot be invested in directly.

Call to Action 

The most likely next move for the Fed will be a cut in rates. The real debate is the chronology of those cuts. Despite the apparent delay in the next action by the Fed, investors are still optimistic about holding equities, and so LPL Research recommends staying invested and maintaining a neutral tactical stance on equities. We expect some volatility in the near term, but equity markets could experience a positive catalyst as weaker labor costs allow the Fed to commence its next move.  

Jeffrey J. Roach profile photo

Dr. Jeffrey Roach

Jeffrey Roach guides the overall view of the economy for LPL Financial Research and has over 20 years of experience in investing and economics.