Yes, inflation is moving higher, according to a number of broad measures.
Those measures include the U.S. Federal Reserve’s favourite, the U.S.
Personal Consumption Expenditures Price Index, which continues to approach
its 2% target level. That gauge has only rarely and briefly done so since
the Fed instituted an explicit target in 2012. In Canada, the official
annual inflation rate rose from 1% in June 2017 to just over 2% this
spring, according to Statistics Canada.
What’s important to note is that where inflation is concerned, higher isn’t the same as high.
No cause for alarm
In Vanguard’s economic and market outlook for 2018, our economics team
listed an inflation surprise as the greatest risk to the status quo. Global
growth was becoming more synchronized at a time when 80% of the world’s
major economies were already at full employment, and commodity prices
looked set to rebound off recent lows. The result, we explained, was high
odds of a cyclical upturn in inflation – something the markets weren’t
pricing in at all.
Don’t confuse the cycle with the trend
A cyclical uptick in inflation, even if it temporarily overshoots central
bank targets, wouldn’t cause the damage that hawks fear – a decline in
purchasing power or an imminent hike in longer-term interest rates, which
could undermine the relatively high prices of stocks and other assets.
Longer term, we expect the economy’s growth and inflation prospects to
remain subdued relative to historical standards, as does the Fed – see its
U.S. forecasts in the graph below. Our research shows that long-term forces
including a shrinking labour force, technological disruption, and expanding
globalization will continue to weigh on prices for years to come.
Those aren’t forecasts that should set inflation alarm bells ringing.
What might “more aggressive” look like?
Our outlook on the Fed’s interest rate plans remains the same: three hikes
in 2018 and three in 2019, taking the Fed funds rate ultimately near 3%
before stopping and, by 2020, perhaps even a cut in rates. Our forecast
anticipates a six-month “pause” in Fed tightening when the Fed funds rate
rises above 2% and above the likely rate of core inflation after September.
This is a differentiated view, as was our view that the Fed would be
“emboldened” to raise rates this year as unemployment rates continued to
So far, we’ve been on point.
Whatever the change, it won’t alter our longer-term market outlook. We
continue to urge investors in Canada and elsewhere to remain disciplined
and globally diversified, armed with reasonable return expectations and
low-cost strategies. The good news is that as short-term interest rates
edge up, so will our expectations for longer-term stock and bond returns,
as the risk-free rate is the foundation for both.
Joseph H. Davis, PhD, is a Vanguard principal and the global head of
The Vanguard Group, Inc.’s
Investment Strategy Group, whose research and client-facing team
develops asset allocation strategies and conducts research on the
capital markets, the global economy, portfolio construction and related
investment topics. As Vanguard’s global chief economist, Mr. Davis is
also a key member of the senior portfolio management team for Vanguard
Fixed Income Group, which oversees more than US$700 billion in assets
Notes and Disclaimer
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