uploads/2014/11/Treasury-yields-continue-to-be-on-the-lower-side-2014-11-281.jpg

Why wage growth could cause rates to rise

By

Updated

So what does this mean for investors? Low rates should support equity valuations and help keep longterm Treasury rates from rising too aggressively. In addition, higher levels of deal activity and higher capital spending levels also tend to act as tailwinds for equity markets. You can read more about my economic outlook in my latest Investment Directions monthly market commentary.

Article continues below advertisement

Market Realist – Wage growth could cause rates to rise.

The graph above compares the yields of ten-year Treasuries (IEF) and investment-grade corporate bonds (LQD)—including those rated Aaa and Baa by Moody’s. Currently, the Treasury yield is 2.3%. It has been driven down by the Fed’s bond buying program. Long-dated Treasuries worth $1.7 trillion were bought in the third round of quantitative easing, or QE3, alone.

The US gross domestic product, or GDP, has seen the best back-to-back quarters, in terms of growth, since 2003. The US GDP grew by 4.6% in 2Q14. It grew by 3.9% in 3Q14. Despite this, Treasury (TLT) yields remain low. However, international Treasury yields are even lower. German and Japanese Treasuries had yields of less than 1%. The British gilt is trading just under 2%.

In the search for better yields, investors entered risky assets—like high yield bonds (JNK) and equities (SPY)(IVV).

Unless there’s wage growth, rates could continue to remain the same for some time. A hike in wage rates could boost consumption and encourage individuals outside the labor force to join. This will increase disposable income. This could get inflation going. It would prompt the Fed to hike rates.

Please read Market Realist’s series Remaining cautious in a real (but uneven) recovery for more information on macroeconomic indicators.

Advertisement

More From Market Realist