The latest labor reports indicate that even in the U.S., the economy remains on uneven footing, giving the Fed room to stay patient. Although employers hired more workers in June, average hourly wages were unchanged at $24.95 an hour from the prior month, a Labor Department report showed July 2.
And the lack of wage pressure is one reason why inflation remains almost non-existent.
Complacency Risk
Annual consumer prices have fallen or remained flat every month this year, and bond traders expect inflation will stay well below the Fed’s own 2 percent target through the end of the decade, data compiled by Bloomberg show.
“The two things that matter most as far as the timing of liftoff is concerned are wage growth and inflation, and right now we don’t have either,” said Ward McCarthy, the chief financial economist at Jefferies Group LLC in New York.
The risk, of course, is that investors in Treasuries underestimate the willingness of Fed officials to lift borrowing costs as they anticipate a strengthening economy and faster inflation. On June 30, Fed Bank of St. Louis President James Bullard said that while Greece’s potential meltdown would spur demand for Treasuries, it’s unlikely to sway policy makers.
“It would not change the timing of any rate hike,” he said. “I would say September is very much still in play.”
In June, Fed officials maintained their year-end forecast for its benchmark rate at 0.625 percent, which implies two quarter-point increases by December.
With inflation so low, the Fed’s fixation on raising rates from rock-bottom levels may actually squelch growth and prematurely cut short any upswing. That may ultimately boost demand for Treasuries, according to Prudential’s Tipp.
“I don’t think they can be that myopic and say they can tighten with all that’s going on,” Thomas di Galoma, the head of fixed-income rates and credit at ED&F Man, said from New York. “We’ve seen the highs for the year” in yields.