Follow Paul Donovan

Are bonds building inflation fears?

| Posted by: Paul Donovan | Tags: Paul Donovan Weekly

The recent rise in US bond yields has raised questions about the US economy. Economists began 2018 having to fend off questions about recession. Now the questions are about overheating and inflation.

Today's yield level is not very high. Ten-year US government bond yields have been over 2.7% for nearly 40% of the post-crisis period. Sitting just above 2.7% is not that scary. It is hard to blame this on inflation now. US wage growth has slowed. January's 3% wage growth is below the levels of the last two years. Headline consumer price inflation has increased a little. The rate will probably increase further this year, but this reflects non-market prices rather than demand overwhelming supply.

Bond investors have more reason to be concerned by the proposed US fiscal stimulus. Building infrastructure is not a low-skilled job. Around four out of every five infrastructure jobs are skilled jobs, and there is a shortage of skilled workers. The US economy will follow one of two paths if fiscal stimulus collides with full employment. Either inflation pressures will pick up as demand exceeds supply. Alternatively, the Federal Reserve will raise rates more aggressively in order to contain inflation (at the expense of economic growth).