Low Wages Keep Rates Low

Don’t rush to get rid of bonds yet. Rising interest rates, which harm bond prices, are not in the offing. Despite good news on jobless figures, the Federal Reserve’s concerns about wages may keep rates low for longer than markets expect.

Another strong increase in job growth, of 209,000 in July, suggests that the economy is improving – and raises concerns that the Fed will pump up rates soon. The number of people who filed for unemployment benefits for the first time dipped to an eight-year low in July. The unemployment rate is now 6.2%, a slight uptick from the month before because more people are in the labor force. But it’s already way past the 6.5% trigger for higher rates set by then-Fed Chairman Ben Bernanke. Additionally, the number of employed persons – as well as job openings – is back to where it was before the financial crisis.

But the Fed doesn’t seem to think that any of this is good enough. Its new boss, Janet Yellen, keeps talking about the “slack” in labor markets and the “slow pace of growth” of hourly compensation. Is she blind to the good news on the labor front?

No, she isn’t. And she has good reasons to be concerned about the labor market, despite the huge improvement of the last five years. The financial crisis hit American wages hard. That blow came on top of a decades-long worsening trend.

The sum of all Americans’ wages grows every year. The number was 16% higher at the end of 2013 than at the end of 2009. The reason simply is: Every year there are more of us. But the wage growth trend, as the graph below shows, took a serious hit after the crisis. The severe departure from previous trends is virtually impossible to make up.

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One way of looking at the decreasing wages in the economy is to examine the share of compensation in relation to gross domestic product. It stumbled after the financial crisis. The sheer departure from previous (decreasing) trends will be virtually impossible to make up.

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Yet another dismal indicator is the annual growth rate of total employee compensation above inflation. After being positive since records started in 1959, it went negative four times in the last 14 years – during the difficult market periods of 2001-2002 and 2008-2009.

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So Yellen is right: Go past the headline employment numbers and a darker picture comes into view. Since she repeatedly indicated that wages rank among her top concerns, the Fed will keep monetary policy loose for a long time to come.

Some argue that the Fed’s easy monetary policy made little progress in bringing up wages, but surely inflated asset prices. If they are right, Yellen’s efforts to improve employee compensation – and therefore reduce inequality – are having the opposite effect. Those who depend on wage income see little difference, while those who don’t – because they make money off their inflating assets – are better off.

The Fed can plausibly argue that its policies need time to take effect, especially because the contractionary fiscal policy of Congress offsets much of what the Fed tries to do. The American economy has long been compared to a supertanker: It takes a long time to turn around.

Fair enough. Yellen can’t turn the whole ship by herself. But turn it must. So unless the government’s executive and legislative branches start working together, don’t blame the Fed for keeping rates lower for longer than most people expect.

That’s why it’s not yet time to sell those bonds.

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Raul Elizalde is president and chief investment officer of Path Financial LLC Investment Management in Sarasota, Fla., where he writes the e-letter Straight Talk.

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