What Does an Increased Minimum Wage Mean for Bonds?

In last week’s State of the Union address, President Obama reiterated his 2013 call for an increased minimum wage. Bond portfolios could be negatively impacted if higher wages cause inflation, which devalues fixed coupon payments. However, economists argue, and SNWAM research suggests, wage growth reinforces but does not cause inflation. Instead, the driver of price increases appears to be inflation expectations. These data, gathered by the University of Michigan and published monthly, indicates inflation expectations in line with the thirty-year average. In other words, consumers do not expect accelerating price increases and therefore have no reason to increase purchasing activity, which would cause those price increases. This is excellent news for bond portfolios for two reasons. First, current income will continue to be only modestly undermined. Second, the Federal Reserve is unlikely to increase its target for the policy rate. This means that, although we expect gradually increasing interest rates in 2014 as the US economic recovery continues, the absence of monetary tightening allows SNWAM portfolios to capture excess return from securities offering higher yields without fear of policy-driven price shocks.