By Erik Norland
Investors appear to believe that inflation will soon come down. The difference in yields between standard U.S. Treasuries and Treasury Inflation Protected Securities suggests that investors now see inflation below 3% going forward.
While the July inflation report assuaged the worst fears of bond investors, there are upside risks to the consensus view that inflation will soon fade. For starters, U.S. employers are looking to hire over 10 million new workers. It’s not at all clear where employers could find so many workers given that U.S. employment has fully recovered from the pandemic.
The intense competition for a limited number of available workers could fuel further gains in wages and prices. Over the long run, the difference between growth in wages and growth in productivity has been a major driver of core inflation. In recent years, wages have been rising by more than 5% annually, whereas productivity gains have been much slower, averaging less than 1% per year over the past three years. Moreover, the total amount of compensation being paid to American workers has been growing by 8 to 10% per year, twice its pre-pandemic pace. As such, a rapid return to low inflation might not be in the cards.
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