Inflation on the Way?

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Economy  |  March 13, 2018  |  
Mike Sanders

New Fed Chair sees “no decisive” signs but prepares for rate hikes anyway

Where is inflation headed?  Price increases have been muted since the 1990s – and have hovered below the Federal Reserve’s 2.0% target since it was set in 2012. Yet news that wages bumped up 2.9% in January, the fastest pace since 2009, jangled market nerves and set off more than a 650-point drop in the Dow in early February.

Not surprisingly, inflation was on the agenda last week when newly appointed Federal Reserve Chairman Jerome Powell testified for the first time to legislative committees. He appeared before the House Financial Services Committee on February 27 and the Senate Banking Committee two days later on March 1.

Powell seemed to strike a more aggressive stance before the House Committee, reiterating plans to hike rates at least three and maybe four times in 2018 to offset the stimulative effects of tax cuts and increased consumer spending. Yet two days later, Powell told the Senate Banking Committee that inflation hasn’t yet become a problem.

“We don’t see any strong evidence yet of a decisive move up in wages. We see wages by a couple of measures trending up a little bit, but most of them continuing to grow at two and a half percent,” said. Powell. “Nothing is suggesting to me that wage inflation is at a point of accelerating. I would expect that some continued strengthening in the labor market can take place without causing inflation.”

The main takeaway: inflation isn’t here yet, and tighter Fed policy is aimed at insuring that it doesn’t arrive — and spiral out of control — any time soon.

Of course, it’s not uncommon for the Fed to begin combatting inflation late in the economic cycle when wages begin to rise. Moreover, it’s not entirely negative for investors for a couple of reasons. First, as rates rise, fixed income securities lose value, but every incremental dollar is invested at a higher rate; over time, higher yields should offset bond price drops. And second, interest rates tend to rise when economic growth is strong and equity markets are buoyant. In this kind of environment, if bond performance suffers, stocks may make up for it.

The important signal to watch is the spread between short and long term rates and an inverted yield curve. The yield curve — or the gap between short- and long-term yields — flattened for most of 2017. A flat or even inverted yield curve (when short-term rates are higher than long-term rates) is often a signal for increased recession risk. However, it has recently begun steepening, indicating stronger prospects for long-term growth.

So while inflation may be rising slightly, the Fed is ready to act as necessary and the underlying fundamentals of the economy seem healthy. Please contact Venturi to discuss our inflation and market outlook in more detail.