Price cuts on everything from iPhones to Folgers coffee show why investors in U.S. government bonds anticipate low inflation for the next decade even as the Federal Reserve considers injecting more cash into the economy.
A measure of price-increase predictions used by the Fed to set policy, the five-year, five-year forward break-even rate, has averaged 2.54 percent this year. That’s the lowest since 2001 for the measure, which gauges expectations for inflation between 2017 and 2022. Economists surveyed by Bloomberg forecast that 10-year government bonds will yield 1.76 percent by Dec. 31, down from 2.76 percent in 2011 and 3.19 percent in 2010.
Bond yields show investors expect that soaring gasoline and corn prices will fail to spread throughout the U.S. economy amid a slump in wages and unemployment at more than 8 percent since the beginning of 2009. That’s giving the Fed scope to add to the $2.3 trillion of government securities it has bought since 2008, an option Chairman Ben S. Bernanke said last week is possible amid “grave concern” about joblessness.
“The bond market doesn’t view inflation as a problem,” Anthony Valeri, a market strategist in San Diego at LPL Financial, which oversees $350 billion of assets, said Aug. 28 in a telephone interview. “The bond market still views deflation as a greater risk to the economy for the next one to maybe two years.”
Treasuries due in 30 years, the securities most sensitive to price rises, yield 2.69 percent after touching 2.44 percent on July 26, the lowest ever. That compares with an average of 3.9 percent in 2011 and 4.43 percent in the last decade.
U.S. government bonds have gained 2.6 percent this year, according to Bank of America Merrill Lynch index data. That compares with 3.8 percent for German bunds and U.K. gilts. Australian securities have gained 5.7 percent.
Yields on the benchmark 10-year note fell 7.5 basis points, the most in seven days, after Bernanke said on Aug. 31 in Jackson Hole, Wyoming, that the labor market is a “grave concern” and that the central bank “will provide additional policy accommodation as needed.”
“The economic situation is obviously far from satisfactory,” Bernanke said in his speech. “Unless the economy begins to grow more quickly than it has recently, the unemployment rate is likely to remain far above levels consistent with maximum employment for some time.”
The 10-year yield rose three basis points to 1.58 percent today. It earlier touched 1.54 percent, the lowest since Aug. 6.
Retailers are responding to sluggish economic growth by cutting prices. Sales rose 0.8 percent in July from the previous month, the biggest increase since February, government figures showed Aug. 14. That followed three straight months of declines, including a 0.7 percent drop in June, the most since May 2010.
“What we’re suffering through in the job market is reverberating through the economy,” Adolfo Laurenti, deputy chief economist in Chicago at Mesirow Financial Inc., which oversees $61.7 billion, said in a telephone interview Aug. 27. “These lackluster sales at many major retailers are really reflecting the fact that budgets are still constrained.”
Average hourly earnings rose 1.7 percent in July from a year earlier, the smallest increase since December 2010 and down from a peak of 3.8 percent in June 2007, the latest Labor Department data show. The Bloomberg Consumer Comfort Index was little changed at minus 47.3 in the week ended Aug. 26, from the prior reading of 47.4 that was the weakest since January.
J.M. Smucker Co., which owns the Folgers coffee brand, lowered retail prices in May by about 6 percent as Arabica bean prices fell. Orrville, Ohio-based Smucker sees lower coffee costs for the remainder of the year, President and Chief Operating Officer Vincent Byrd said Aug. 17.
Procter & Gamble Co., the world’s largest consumer-products company, rolled back $400 million of the $3.5 billion in price increases it made last year, Chief Financial Officer Jon Moeller said Aug. 3 during a conference call. The move boosted Cincinnati-based P&G’s U.S. market share of laundry detergents, including category leader Tide, by 0.6 percent in July, he said.
Bentonville, Arkansas-based Wal-Mart Stores Inc. cut its price for Apple Inc.’s 16 gigabyte iPhone 4S to $148 from $188, which was already cheaper than the manufacturer’s suggested retail price of $199. Second-quarter sales at Wal-Mart’s U.S. stores open at least a year gained 2.2 percent, below the 2.6 percent in the previous quarter, the company said Aug. 16.
Wal-Mart cut prices on paper household products by 14.1 percent in August from a year earlier and health and beauty aids by 13.7 percent, according to Bloomberg Industries data. The cost of laundry goods has climbed 18 percent since September 2010 at the stores, while household paper items have increased 2.3 percent, the data show.
The company announced a program discounting gasoline by 15-cents-per-gallon on Aug. 29. The average U.S. price of a gallon of regular unleaded gasoline has risen 16 percent this year to $3.80, according to AAA.
“Our customers are under pressure from the economy,” Duncan MacNaughton, chief merchandising officer for the world’s biggest retailer, said that day on a conference call. “We have always had aggressive prices on gas. This takes it to the next level.”
A measure of prices tied to consumer spending was the same in July as in the previous month, according to an Aug. 30 Commerce Department report. The core personal consumption expenditure deflator, which excludes food and energy costs, rose 1.6 from a year earlier, down from 2.2 percent in March.
The consumer price index was unchanged for a second month in July after plunging 0.3 percent in May, the most since December 2008, according to the Labor department.
The Fed’s preferred long-term gauge of the bond market’s expectations for inflation, the five-year, five-year rate, is down from 2.78 percent in March and has averaged 2.74 percent during Bernanke’s tenure since February 2006. That compares with an average of 2.67 percent between 2000 and 2010.
There is concern that flooding the financial system with cash will eventually spark runaway inflation as the $1.48 trillion in excess reserves held by U.S. banks feeds back into the financial system.
Commercial and industrial loans at banks have risen to $1.46 trillion from a post-crisis low of $1.2 trillion in 2010, according to the Fed. The peak was $1.61 trillion in 2008.
“All of the monetary policy is like filling your house basement with gas and hoping it won’t catch on fire,” Scott Minerd, chief investment officer of Guggenheim Partners LLC, said Aug. 24 in a telephone interview. “All it needs is a spark and it will be a conflagration,” said Minerd, whose firm oversees more than $125 billion from Santa Monica, California.
The Republican Party platform adopted at its national convention calls for a commission to investigate a possible “metallic basis for U.S. currency.”
The move was driven by supporters of Representative Ron Paul of Texas, who has long criticized the Fed’s control of the money supply and wants to revive the link between gold and the dollar to preserve the currency’s value.
President Barack Obama will accept the Democratic Party’s nomination for reelection this week at their convention in Charlotte, North Carolina. Lower inflation and bond yields have helped his administration finance a fourth-straight deficit exceeding $1 trillion.
The Congressional Budget Office forecasts interest on government debt will equal 1.4 percent of gross domestic product this fiscal year, less than the 3.1 percent when Democrat Bill Clinton ran for re-election in 1996 and 3.2 percent when Republican George H.W. Bush ran in 1992.
Investors remain bullish on bonds, in part, because wages are stagnating even though commodities prices have risen.
Food price inflation caused by the worsening U.S. drought, as well as higher gasoline prices, is being offset by employment and wages that have failed to recover sufficiently, Valeri said.
Corn has surged 57 percent since June 15, reaching a record $8.49 a bushel on Aug. 10, as the drought parched millions of acres across the U.S. Soybeans gained 33 percent since mid-June and reached a record $17.605 a bushel on Aug. 27. Oil touched a 15-week high of $98.29 on Aug. 23, and gained 20.9 percent on Aug. 31 to $96.47, as Tropical Storm Isaac strengthened, crimping output in the Gulf of Mexico.
“The real driver of inflation is labor costs, how much people are making,” LPL Financial’s Valeri said. “Salaries aren’t increasing much at all.” Valeri said he favors intermediate-maturity corporate bonds because “interest rates are going to stay low for a while.”