Sure, much US economic data has been weak, and sure, we may see fallen leaves drifting in the streets of Washington before the Federal Reserve actually hikes rates, but the most important development may turn out to be the rise in employment costs. The employment cost index (ECI) rose more than expected in the first quarter, up 2.6 per cent compared with a year earlier.

Private sector ECI is up 2.8 per cent year-on-year, compared with 2.4 per cent in the fourth quarter of last year. Considering the likely hammering that pay and benefits in the oil patch, hard hit by the fall in energy production, will have taken, this is one more piece of data indicating a labour market returning to normal. Normal means a bit of wage pressure, and wage pressure means a bit of inflation.

Inflation, especially coming out of a healthy labour market, will be hard for the Fed to ignore and may force it to rapidly reassess the risks and benefits of an interest rate hike. To be sure, most of the focus has been on news tending to indicate that the Fed will be on hold for longer.

The economy expanded by just 0.2 per cent in the first quarter, hurt not just by cold weather but by a discouraging fall in business investment. Hours after the GDP release on Wednesday, the Fed, in keeping rates on hold, gave the impression of requiring more convincing evidence before embarking on its first tightening since 2006.

“Economic growth slowed during the winter months, in part reflecting transitory factors,” the Fed said. “The pace of job gains moderated, and the unemployment rate remained steady.” The Atlanta Fed’s GDPNow real-time estimate of second quarter growth is running at only 0.9 per cent, well below most economists’ forecasts.

While a summer rate hike was considered a possibility earlier in the year, markets now assign a rate hike by October only 46 per cent probability. And yet, though a patient Fed should be good for risk assets, none of this seems to have reassured markets. Since the Fed made its announcement on Wednesday, shares have fallen and bond yields have risen.

Even beyond the strength in employment costs, there are a range of labour market and wage indicators that paint a picture of a more normal labour market.

Federal withholding tax receipts for April were 5 per cent higher than the previous year. First-time claims for unemployment benefits were only 262,000 last week, the lowest level in 15 years. Job openings were at a 14-year high in February, according to Labor Department data, and the number of people leaving their jobs voluntarily, a good barometer of demand for labour, is also at a healthy level.

And that’s before we get to the growing anecdotal evidence of wage pressures at the lower end, with retailers such as Wal-Mart and Target announcing increases along with hikes planned at 15,000 McDonald’s restaurants.

All of this is in contrast to the last nonfarm payrolls report, which saw just 126,000 jobs created in March, the lowest in 15 months. The alternative narrative is that there remains a large pool of sidelined labour, people who’ve left the work force but will gladly return as conditions improve, thus keeping a lid on wage growth. That’s certainly possible, but is hard to square with decent wage growth in a quarter with little or no expansion and a loss of momentum in the creation of jobs.

All of this sets up the April nonfarm payrolls release, slated for May 8, as a bit of a test. If job creation rebounds well, and if wage data looks reasonably strong, financial markets may begin to discount the possibility of a more hawkish Fed, if only slightly more.

For equities, this could be a bad combination. While wages mostly get spent and thus stimulate the economy and help corporate profits, all 100 cents of the wage dollar is a cost to employers.

Given that the trend in revenues is flat, it won’t take long to work out the profit implications of a sustained rise in wages.

— Reuters