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Is it time to worry about inflation? No.
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By Fund Library News Wire  | Tuesday, July 31, 2018


By Joe Davis, Global Head, Investment Strategy Group, Vanguard Group, Inc.

Global markets were caught off guard at the end of January by a pickup in wages in the United States. Then came trade tariffs that will push up import prices on both sides of the U.S.-Canada border. Oil recently breached US $70 a barrel. And the effects of the Trump administration’s tax cuts and increased federal government spending are also coming down the pike. In Canada, the U.S., and several other countries, inflation has been inching upwards. In some parts of the world, inflation hawks are increasingly concerned.

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 drop.

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 under management.

Notes and Disclaimer

© 2018 by Fund Library. All rights reserved. Reproduction in whole or in part by any means without prior written permission is prohibited. This article first appeared on the “Education & Commentary” page of the Vanguard Group, Inc.’s website. Used with permission.

Important information

The views expressed in this material are based on the authors' assessment as of the first publication date (July 2018), are subject to change without notice and may not represent the views and/or opinions of Vanguard Investments Canada Inc. The authors may not necessarily update or supplement their views and opinions whether as a result of new information, changing circumstances, future events or otherwise.

While this information has been compiled from sources believed to be reliable, Vanguard Investments Canada Inc. does not guarantee the accuracy, completeness, timeliness or reliability of this information or any results from its use.

This material is for informational purposes only. This material is not intended to be relied upon as research, investment, or tax advice and is not an implied or express recommendation, offer or solicitation to buy or sell any security or to adopt any particular investment or portfolio strategy. Any views and opinions expressed do not take into account the particular investment objectives, needs, restrictions and circumstances of a specific investor and, thus, should not be used as the basis of any specific investment recommendation.

All investments are subject to risk, including the possible loss of principal. Diversification does not ensure a profit or protect against a loss in a declining market.

This material does not constitute an offer or solicitation and may not be treated as an offer or solicitation in any jurisdiction where such an offer or solicitation is against the law, or to anyone to whom it is unlawful to make such an offer or solicitation, or if the person making the offer or solicitation is not qualified to do so.

Investors should consult a financial and/or tax advisor for financial and/or tax information applicable to their specific situation.

In this material, references to "Vanguard" are provided for convenience only and may refer to, where applicable, only The Vanguard Group, Inc., and/or may include its affiliates, including Vanguard Investments Canada Inc.

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