That Pay Raise You’re Waiting on Fails Bond-Market Reality Check

A major problem for the U.S. economy since the 2008 crisis has been that workers just can’t seem to get the pay raises that’ll allow them to spend more. Bond traders don’t see this issue going away anytime soon.

While Federal Reserve Vice Chairman Stanley Fischer indicated this week that he expected inflation will eventually accelerate, debt traders are betting the opposite will happen. They’re boosting wagers that the world’s biggest economy is slowing, with a gauge of expected inflation over the next 12 months turning the most negative since 2012 on Friday.

After all, the U.S. doesn’t operate in a bubble. The nation must contend with China, which is decelerating so rapidly that its government shocked markets this week by devaluing the yuan by the most in decades. And the U.S. faces weaker growth in all the developing countries that depend on China’s expansion to support commodities from oil to metals.

“Particularly in the month of July, we saw a big increase in deflationary fears,” Jeffrey Rosenberg, BlackRock Inc.’s chief fixed-income strategist, said in a Bloomberg Television interview Tuesday. China’s move to decrease the value of its currency “is going to just feed into that.”

‘Temporary’ Inflation

For a sense of just how worried investors are about a cooling U.S. economy, check out longer-dated Treasuries, which stand to lose value if consumer prices increase, as inflation erodes their returns. The debt has gained 4.4 percent since the end of June compared with a negative return on dollar-denominated corporate bonds, according to Bank of America Merrill Lynch index data.

Yields on 30-year Treasuries have declined to 2.8 percent from 3.2 percent at the end of June even as the Fed moves closer to raising interest rates for the first time since 2006, possibly as soon as September.

Here’s the dilemma: While the U.S. unemployment rate has fallen to 5.3 percent from 10 percent in 2009, workers’ wages have remained fairly stagnant and inflation has been weighed down by oil near a six-year low.

Consumer prices rose 0.1 percent in the 12 months ended in June, the first year-to-year increase since December, after being little changed in the year ended in May.

“A large part of the current inflation is temporary,” Fischer said in an interview Monday with Tom Keene on Bloomberg Television. After the effects of cheaper oil and other raw materials dissipate, “these things will stabilize at some point, so we’re not going to be as low as we are forever.”

Bond traders don’t think this trend is so passing, and are indicating they expect the current backdrop of economic malaise to continue for at least another year. The one-year break-even rate, a gauge of the inflation outlook derived from the yield difference between Treasuries and index-linked securities, has fallen to negative 0.82 percent, compared with this year’s peak of 1.8 percent in April.

So Fed officials may be confident enough in U.S. inflation to still raise rates next month. But debt investors are betting big bucks that they’re wrong.

Before it's here, it's on the Bloomberg Terminal. LEARN MORE