If you’ve been watching the news, it’s safe to say that you’ve heard about the rosy labor market. As of the second quarter of 2018, the United States’ tightening labor markets had added 18 million jobs since 2010.1 Ample opportunities are a positive for today’s workforce, but what’s the trickle-down impact on their investment portfolios?
Currently, the U.S. is experiencing its lowest unemployment rate in 17 years, and businesses are feeling pressure to recruit and retain top employment.1 As a result, workers are seeing bigger paychecks, with average total compensation rising from $26.54/hour for November 2017 to $27.29/hour one year later.2
And rising wages aren’t isolated to one particular industry. Increased labor costs are evident across the board.
So while this may mean more money in your pocket initially, how is it impacting your investments? If you’re not preparing, you may actually find yourself with less money at the end of the day.
Concerns of rising interest rates and inflation
Although talks of looming inflation increased in 2018, it still remains relatively modest. Currently, inflation in the U.S. sits at roughly two percent – right around its benchmark. And economists are now forecasting slower economic growth for 2019, predicting only two interest rate hikes (but even that’s up in the air).3
If this comes to fruition, and inflation doesn’t rise, the Federal Reserve may end its rate normalization process sooner than expected. This has the potential to leave the Fed with little-to-no monetary power to cut rates if a recession hits and keeps traditional fixed coupons well below their historical averages.
Keep in mind that inflation may still rise, forcing rates even higher. If inflation does in fact rear its ugly head, the Fed may react aggressively, possibly even using a 50-basis point hike to eliminate it. It could be highly destructive for fixed-income investments.
With both of these scenarios a possibility, how can you prepare?
Preparing adequately for all possibilities
Traditional fixed income struggles when interest rates rise. Investments that pay a fixed coupon may lose their value, forcing investors to sell at a discount and possibly lose their principal. On the other hand, if rates stop rising, we are back in a familiar situation, and bond yields may not provide the income you need.
One potential solution may be an allocation to floating-rate assets. Senior secured loans typically pay steady income with downside protection in any rate environment.
It’s tough to predict the future
It’s too early to tell if the tightening labor market will result in an inflationary environment. But inflation is currently modest, and market volatility may curb the Fed’s current rate policy. It’s important to keep your goals in mind and allocate to investments that have the ability to hedge against these issues as they arise.