After the Great Recession, the Federal Reserve kept interest rates low to help grow the economy. And by many measures, it’s worked. Job growth is humming along and unemployment is at its lowest level since 2008. These promising signs gave the green light to start normalizing interest rates in late 2016. However, inflation continues to fall short of expectations.
Why is this? The Fed has laid out several plausible theories, including, the global economy suppressing wage growth and cheap imports holding down the cost of goods.
Low inflation has put the Fed in an economic conundrum. Typically, it raises interest rates in part to reduce inflation. However, the Index is already sitting well below its two percent target despite promising topline job numbers and still-low rates. If it falls further, that may signal an economic slowdown.
Some market observers point to tepid wage growth and low workforce participation as potential reasons why the Fed should re-evaluate its policy. However, the Fed – while cautiously concerned – is not panicking. It believes it must carry on since the economy is basically at full employment with little slack in the labor market.
What does this mean for investors searching for income? A flattening U.S. yield curve is being driven by mixed economic and policy signals. Short-term Treasury rates are moving higher on Fed policy expectations, but longer-term yields are still taking their cues from a mixed inflation and economic outlook. Investors seeking risk-adjusted income may need to look somewhere else.
Real estate may be one option. If inflation does start moving towards its benchmark, investments in real estate may serve as a hedge for investors. Property values tend to rise with increasing inflation, as rents can be raised to keep pace with an overall increase in prices.
At Resource, we are keeping one eye on inflation to gauge the economy’s overall health, and another on how its movement impedes or opens the Fed’s continued march to normalized interest rates.