Bigger Paychecks Make Consumers Smile

Consumers are feeling more optimistic because they finally are making more money. It’s as simple as that.

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Economic data confirmed that Friday and the figures adhere to a strengthening narrative in which the Federal Reserve absorbs a slew of recent positive numbers and announces a long-awaited interest rate hike at its next meeting in September.

A gauge of consumer sentiment rose in June to 96.1, according to the University of Michigan, up sharply from May’s reading of 90.7 and well above the Thomson Reuters estimate of 94.6. It marked the highest reading since January.

“Consumers indeed have much to be cheery about, including rising payrolls, accelerating wage growth and lower gasoline prices relative to a few months ago,” Gregory Daco, head of U.S. Macroeconomics at Oxford Economics, said

And the good news is likely to continue, according to Daco, fueled by consumers with more money in their pockets.

“After a soft start to the year, we expect the economy to find its footing in the coming months with stronger consumer spending seen to be a key driver of accelerating GDP growth,” he said. “Stronger wage growth, as most recently indicated in the May personal income and spending report, as well as continuing payroll gains and high confidence will all push consumer spending growth to around 3% in 2015.”

Two key statistics are at the root of rising consumer optimism. First, a 2.3% year-over-year hourly wage increase included the May jobs report, which suggested for the first time in months that employers are starting to address the tightening labor market by raising wages to attract qualified workers.

The 2.3% annual increase is still well below the 3% year-over-year figure the Fed would prefer, but it’s definitely a move in the right direction.

Second, a more obscure report from the labor market earlier this month revealed that the number of job openings at the end of April stood at 5.4 million, the largest number since the government started keeping track in late 2000.

Meanwhile, hiring fell to 5 million in April down from 5.1 million a month earlier, a drop economists said occurred because employers are having difficulty finding the qualified workers they are seeking.

For months, economists have been vexed by two contradictory economic indicators: a rapidly falling unemployment rate and a weak inflation rate. Simple rules of supply and demand suggest one should directly impact the other. To wit, a dwindling supply of qualified workers should push wages up for those workers, which will in turn move prices higher and lift inflation toward the Fed’s 2% target range.

But that wasn’t happening and while it didn’t the Fed was reluctant to raise rates for fear that prematurely raising borrowing costs could push the economy back into recession. The Fed has said it won’t raise rates until unemployment hits a range of 5.2%-.5.6% (unemployment stood at 5.4% in May) and inflation reaches 2%.

Now wages are finally moving higher which should nudge inflation toward that Fed goal, just as central bank economists predicted it would, allowing them to raise rates in September if everything remains on track.

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