"Also, by setting a long-term target for unemployment of 5% to 6%, the FOMC is also acknowledging that labor market conditions are not likely to improve enough to allow inflation to take hold for years. YoY average hourly earnings have held to a range of roughly 2% to 4% for the past thirty years. Historically average hourly earnings have not moved toward the upper end of that range until the unemployment rate is below 6%. With the unemployment rate at 8.5% and average
hourly earnings growth at 1.9%, there is a long way to go before labor market conditions will support a persistent rise in inflation."
Good news for holders of financial assets, particularly bonds, but not good news for middle class workers and for new entrants into the workforce. Ironically, just when the risk-reward profiles for most corporate investments are also getting a boost, CEO's continue to be reluctant to invest in new product development and market expansion, according to McKinsey.
Capital investment against this kind of labor market backdrop would have the potential to raise labor productivity, which would be good for both earnings of the corporation and its workers. If productivity picked up, then a rise in earnings would itself not have to be inflationary. The difference between projected GDP and potential GDP levels is considerable. There seeems to be little potential for energy or commodity driven inflation either. So the difference between nominal and real returns will also be small. There's little room for a rise in inflationary psychology either.
Going into the cycle, executive compensation schemes probably induced too much risk taking, especially in financial services. One wonders whether we've flipped psychology on its ear. By cutting expenses, standing still and using excess cash to buy back shares while not having a long term vision for creating value, perhaps some of those same CEO's are being too risk averse here.
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