EXECUTIVE SUMMARY
Labor costs are cooling without collapsing. Q4 2025 compensation growth decelerated to 3.4% year-over-year from 3.8% a year ago, with quarterly gains moderating to 0.7%. Real wages up just 0.7% annually explains why December retail sales flatlined - consumers have no extra spending power. The Fed gets the gradual wage moderation it wants, but services inflation will remain sticky.
KEY FINDINGS
• Compensation costs: +0.7% QoQ, +3.4% YoY (down from 3.8% in Dec 2024)
• Wages & benefits: Both rose 0.7% quarterly, 3.3%-3.4% annually - balanced labor cost growth
• Real wage gains: +0.7% YoY - workers barely keeping pace with inflation
• Health benefits spike: +6.4% YoY, eroding take-home pay despite nominal wage gains
ANALYSIS
Compensation costs rose 0.7% in Q4 2025, matching Q3's gain but down from the 0.8% quarterly increases seen earlier in the year (FRED: ECIALLCIV). Year-over-year growth decelerated to 3.4% from 3.8% in December 2024 and 4.7% in state/local government a year earlier. Wages and benefits both increased 0.7% quarterly - no divergence between the two, suggesting broad-based but moderate labor cost pressures.
The union vs non-union split reveals where bargaining power remains: union workers extracted 4.3% wage gains versus 3.3% for non-union workers. This reflects successful contract negotiations in auto, logistics, and healthcare sectors, but it's not spreading economy-wide. Most workers are seeing wage growth moderate toward the 3% range.
This data directly explains December's retail sales flatline. With real wages up just 0.7% year-over-year, consumers have essentially zero growth in purchasing power. They're treading water, not gaining ground. The sharp pullback in discretionary spending after Black Friday makes perfect sense - households can afford deals, not full-price purchases.
Health benefit costs surging 6.4% annually compounds the problem. Even if your paycheck grows 3.3%, rising healthcare costs (premiums, deductibles) eat into what's left for actual consumption. This is why goods spending is weak while services spending (which includes healthcare) remains elevated - it's not choice, it's necessity.
The quarterly deceleration from 0.8% to 0.7% signals the labor market is normalizing without breaking. Unemployment remains low (4.4%), but employers no longer need to bid up wages aggressively to fill positions. The post-pandemic wage-price spiral risk has largely dissipated.
Expect continued gradual moderation in wage growth through 2026. We're settling into a 3.0%-3.5% range - sustainable, but not exciting for consumers. This keeps the Fed patient on rate cuts. With labor costs still growing above their 2% inflation target, they won't rush to ease policy.
Consumer spending will remain cautious. Goods consumption stays weak (as December retail sales showed), while services spending holds up. The bifurcation continues: experiences over things, but only because real wage growth is too low to support both.
MARKET & FED IMPLICATIONS
Markets should interpret this as dovish-neutral. Labor costs are moderating, reducing inflation risk, but not collapsing fast enough to force emergency rate cuts. The Fed's "higher for longer" stance remains appropriate - expect rates to hold steady through Q1 2026, with potential cuts in Q2 if this deceleration trend continues.
The stickiness in services inflation (driven by these 3.3% wage gains) means the Fed's 2% target remains distant. Core services inflation will stay elevated above 3% through mid-2026. Disinflation is happening, but it's slow and grinding.