Yesterday the bond market priced in a 3 year inflation expectation of 1.4%. Today the CPI data was released: My favorite measure, core inflation, ex-shelter rose to 1.53%, near the 2016 high of 1.6%. I maintain that shelter is measured incorrectly, forcing those who live debt free to calculate a hypothetical cost as if they were paying market rent for their residence – ridiculous! The Fed’s PCE inflation measure tends to reduce this problem which is why PCE is usually 0.25% lower, although it could be even lower. YoY the core rate was 2.1%. Shelter was 3.2% YoY. Core commodities were up 0.2% YoY.
The dominant economic paradigm of the past 30 years has been globalization where capitalists constantly move factories around to whatever country gives them the best cost savings. The white collar professionals used to be immune from this but in the past decade a great many opportunities have arisen that allow employers to move white collar work from Developed countries to low wage EM countries. More Americans are doing medical tourism, including Skype-based “office visits” to doctors, saving money by using doctors located in EM countries.
It takes a lot of effort for corporations to persuade consumers to buy something. It is easier instead to simply get good at cutting costs and increase profits that way, rather than go broke overspending on advertising in hopes of recruiting customers.
I don’t expect a repeat of the usual cycle where inflation rises significantly as the final year of a seven year economic cycle is reached. This is because employers are firmly committed to offshoring to cut costs and to avoid losing control over costs, including avoid letting domestic workers get used to pay raises.
Assuming stocks are overpriced by a factor of 2 (using measures such as PE, PS, Price to GDP, etc.) then I prefer to avoid a 50% stock crash by waiting to buy at the right price and holding assets in bonds, even if inflation reduces the real return. The key to this is to see if inflation is reasonable and stable. Based on the dismal results of Japan and the EU to reflate their economies despite negative interest rates I think worrying about inflation is a far lower priority than worrying about getting stuck in a debt/deflation traps where no one wants to buy anything because of excess debt, low growth, low inflation, etc. Assuming China’s economy eventually is unable to restimulate with a new round of debt fueled stimulus then a slowdown there will spread worldwide.
A big myth is that bond investors used to get huge yields in U.S. history, but that was rarely the case except for the time the Fed fought off inflation in 1979-1986 under Volcker, which had a residual effect of high interest rates that lasted until the recession of 2002. Excluding 1965-2002 and wartime, U.S. inflation has typically been around 0.7%. One can blame that on the 19th century gold standard but today we have an even more deflationary force of globalization beating down wages. In the 19th century importing was rare and difficult; things were consumed close to where they were made. Thus today’s disinflationary forces of globalization are stronger than the ancient gold standard.
Investors need independent financial advice about the risks of misunderstanding inflation and bond yields.