Friday’s jobs report, and the stock market selling off in response to faster wage growth and the prospect of higher inflation, shows the quandary Democrats are in heading into the midterm elections.
The Republican tax bill’s benefits were targeted toward corporations and investors. They’re also the ones whose tax cuts were made permanent, unlike households. Yet with the bill signed into law, the way people will evaluate it is probably based on what happens to wage growth and the stock market. And there’s a very real scenario for this year that would make Democrats’ message on the tax bill look wildly off the mark.
The problem with saying the tax bill won’t do much for workers is that it was passed at a time when the unemployment rate is low and wage growth is likely to accelerate based on where we are in the business cycle. And indeed, that’s what last week’s economic data showed.
On Wednesday, the employment cost index showed that compensation for workers is at its highest level of the expansion. And on Friday, the jobs report showed the same thing. Over the past year, wage growth averaged 2.9 percent. Shrinking the sample size just to the past three months, wage growth has risen at an annualized rate of just over 4 percent. If wage growth heading into the final weeks of the campaign continues to accelerate from here, it’s going to be hard for Democrats to campaign on the idea that the tax bill did little for workers.
The other piece of the tax bill — its benefit to corporations and investors — may be a challenge for Democrats as well. The stock market has risen so much over the past few months in part on tax bill optimism, and in part on the state of global economic growth. Yet at the same time that stock markets have rallied, we’re seeing signs that some of the “crowding out” impacts of the tax bill may be more real than investors anticipated as well, a potential negative for stocks down the road.
That strong wage growth the past few months also creates the possibility that corporations may have to raise wages more than they anticipate, cutting into their profits. The price of oil is up $20 a barrel since the end of August, raising energy and transportation costs for the economy, creating profit-crushing cost pressures for some industries and leading to the prospect for broader-based inflation.
And interest rates have been rising strongly of late, creating multiple concerns for investors. First, it means the Federal Reserve may increase interest rates faster than previously thought, slowing economic growth and raising the potential that the economic cycle will end earlier than anticipated. Second, corporations issued a lot of low-interest debt beginning in 2012, and as that comes due it will need to be reissued at higher interest rates, increasing debt expense, which comes right out of corporations’ bottom lines. And third, as interest rates go up, bond yields look relatively more attractive, putting downward pressure on stock prices.
Perversely, a tax bill that gave workers short shrift and a windfall for corporations and investors may, in the short run, appear to have the opposite outcome. Wage growth may accelerate due to cyclical momentum that had been in place for years. And the prospect of higher interest rates, a more aggressive monetary policy tightening cycle, and cost pressures may make 2018 a bad year for investors.
This doesn’t mean that the midterm elections will turn out poorly for Democrats. In 2006, a strong economic year, Democrats flipped 31 seats in the House and five in the Senate, taking control of both chambers. President Donald Trump’s approval rating is far below how presidents tend to be seen in such thriving times, indicating that voters are likely to be motivated by factors other than the economy this year.
But the Democrats would be wise not to become too anchored to the impact of the tax bill, because the economy has a way of making fools out of all of us.
Conor Sen is a Bloomberg View columnist.