Where is Inflation?

Thursday, February 1, 2018 |

In my last post, we looked at the rare levels of subdued equity market volatility and how odd this seems given the rising geopolitical tensions around the world. Nevertheless, corporate earnings have continued to power higher amid freshly passed tax reform, consecutive quarters of 3%+ GDP growth, and the lowest levels of unemployment in over 40 years. But stuck hovering around 1.8%, the question everyone including the Fed is asking: Where is inflation?

The question is perplexing because based on historical accounts, conditions that garner increased inflation are present: Strong growth, tight labor markets, and rising raw materials prices.

Source: Wall Street Journal
 

We observe several themes linked to suppressed inflation:

 

  1. New developments in technology drive down company costs, with savings/benefits being passed on to end consumers. Good examples of this are wireless services and airline fares which saw prices decline 10% and 4% respectively in 2017 (See chart above).^
 

 

  1. Wage rate growth has been immaterial at just 5%, largely attributable to highly paid baby boomers retiring and lower earning entry-level workers replacing them. Cities with the tightest labor markets are the first areas seeing wages slowly begin to pick up.^^

     
  2. A shared belief among industry leaders is that when inflation finally does show up, it may come as an unexpected shock that strong-arms the Fed into hiking rates faster than markets anticipate. Additionally, as the Fed continues along its path toward balance sheet normalization, increased bond market supply could pressure yields higher.
Source: Alger, FactSet
 
Going forward, investors should keep an eye out for inflationary surprises that could push the Fed to tighten policy swiftly – and the negative effects that could have on equity prices. Something else to keep in mind as is commonly stated: Inflation plays are a trade, not a long-term investment.
 
 

Title Chart Source: DoubleLine

^ Borodovsky, Lev. “The Daily Shot: Tariffs on Chinese Steel Imports Will Backfire.” WSJ.com, The Wall Street Journal, 17 Jan. 2018, blogs.wsj.com/dailyshot/2018/01/17/the-daily-shot-tariffs-on-chinese-steel-imports-will-backfire/.

^^ Doll, Robert. “Weekly Investment Commentary.” Nuveen.com, 29 Jan. 2018, www.nuveen.com/Commentary/BobDoll/WeeklyCommentary.aspx.

Inflation is the rise in the prices of goods and services, as happens when spending increases relative to the supply of goods on the market.  Moderate inflation is a common result of economic growth. 

 

The bond market is volatile and carries interest rate, inflation, liquidity and call risks. As interest rates rise, bond prices usually fall, and vice versa. Change in credit quality of the issuer may lead to default or lower security prices. Any bond sold or redeemed prior to maturity may be subject to loss.

 

The views and opinions expressed herein are those of the author(s) noted and may or may not represent the views of Capital Analysts or Lincoln Investment.

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