The 10-year US Treasury hit its low last summer at 0.50%. Over the next nine months that rate pushed up to 1.70% as vaccine development and distribution allowed business to move back towards normal. Since then, rates have moved steadily downward in the face of higher inflation readings than we have seen for a long time. Behavior like this usually reflects concerns over economic growth and more of the associated monetary easing we expect from the Federal Reserve. But there is nothing usual about fixed-income markets today.
Start with the economy. First-quarter GDP grew 6.4%, and second-quarter forecasts are for 9.0%. Even the Federal Reserve is forecasting 7.0% economic growth for 2021, a significant jump from what they expected only last December. Demand has overwhelmed supply in so many sectors it is becoming old news. Housing, automobiles, anything that requires a microprocessor is all in short supply. Jobs are going unfilled in factories and retail stores. Restaurants are offering signing bonuses and shutting dining space for lack of staff.
As a result, wages are going up. When jobs go unfilled, business owners can’t automate fast enough to fill the gap immediately. They resort to paying higher wages to stay competitive and maintain short-term productivity. Dozens of large companies have raised their minimum wage to $15 or more and smaller business owners have little choice but to follow suit. To maintain margins, companies will pass these costs to their customers. Nothing in this scenario suggests a need for more accommodative monetary policy or lower rates.
With that in mind, consider inflation and how long it will stick around. June’s survey of small business owners, conducted by the National Federation of Independent Businesses (NFIB), found that 47% of business owners are raising their average selling prices. This is the highest reading since January 1981 at the tail end of the inflationary period of the 1970s. The non-partisan advocacy group The Senior Citizens League raised their estimate of the Social Security cost-of-living adjustment for 2022 from 5.3% to 6.1%, the biggest increase since 1983.
Meanwhile, the Federal Reserve has gone to great lengths to position current inflation levels as transitory. They point out that the significant April and May year-over-year price increases stem from the depressed prices at the start of quarantines in 2020. They believe that inflation pressures will moderate thereafter and rate increases are not needed yet.
So are they right? Even FOMC inflation forecasts have risen substantially as the year progresses. With any economic figures, trends are more useful than point-in-time data, and this trend is worrisome. As of June, 12-month PCE inflation is at 4.0%, the most recent 6-months of PCE data annualized is 5.6% and 3-months annualized is 6.4%; inflation is picking up speed. Keep that in mind as we consider the requirements needed to find ourselves only at the 3.4% FOMC forecast by year-end. In order to limit 2021 inflation to the FOMC projection requires monthly inflation numbers over the remainder of the year to be half of the monthly data reported so far. When every trend shows inflation accelerating.
To sum up, the Federal Reserve expects inflation to moderate and pull back slightly while at the same time their GDP forecast increased by 70%, wages are rising, inflation has been picking up speed, and monetary policy remains as loose as ever. Between their words and the data, we’ll follow the data.