Will Wage Increases Destroy Bonds?

The employment cost index is up 3% annualized in the past half year. Does that mean workers are getting inflation causing raises? Will this make bond prices go down?

I suspect this statistic is warped by outsized gains for the top 10% who may be getting temporary unsustainable bonuses. Once the tech boom fades, as the Social Media industry becomes less credible, this income will decline, pulling down the average. If the bottom quartile of workers gets big raises they won’t be able to cause inflation because they have a hard time to qualify for loans. It is the growth of loans that increase the money supply and create inflation. Even if the bottom quartile of workers were able to get a loan they would be limited by debt to income ratios and thus would not be able to get much debt.

The key to rising profits has been cutting costs instead of raising prices and increasing sales. In a disinflationary low growth economy the trend will continue, especially when Europe and Japan offer an ample supply of surplus labor of skilled workers. Corporate America will continue to export jobs to cut costs and to qualify to allocate more profit to offshore tax haven countries.
  Thus the Fed won’t be raising rates any time in 2015. I suspect the economy will start to show some scary cracks in late 2015 including junk bonds and small caps diverging from the SP500 so the Fed will be unable to raise rates for a few more years. This divergence is already happening.

The drivers of the old normal economy were young people and moderate income people getting decent jobs and entry level housing and home appreciation. The home equity could be extracted and used to fund a small business. Now this dream has been severely changed for moderate income people, with only the top 10% able to participate at a pace that occurred before the 2007 mortgage crash. The rate of formation of small business has been significantly lower since 2007. These businesses are the source of new jobs for entry level workers because the owner may not be able to screen out rookies and may be forced to give them a break. Thus the loss of this type of employer helps to explain why unemployment is so high for young people.
   I don’t expect employers to hand out inflation causing raises to middle and lower skilled workers. The slowdown in the oil fracking business due to lower oil prices should help to hold down wage increases.

The risk to bonds is in the opposite direction of a risk of an inflationary expansion of the economy, which is the risk that the economy could fall into recession when debt loads are high, resulting in defaults and ratings downgrades rather than inflation making bonds go down by raising the discount rate of bonds.

After the next recession perhaps some new stimulus program will finally cause inflation. But remember despite the stimulus of the Great Depression inflationary pressures didn’t break out until 30 years later (with the exception of the immediate post-war period).

Investors need independent financial advice about the risks of inflation and bonds. I wrote an article “Best measure of labor market shows disinflation risk".

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Don Martin

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