Source: U.S. Bureau of Labor Statistics
While the labor market may take years to return to the 3.5% pre-pandemic unemployment rate, recapturing this level may not even translate into meaningful inflation (after all, it didn’t before). The Fed has adjusted its estimate for the non-accelerating inflation rate of unemployment (NAIRU) over the years, lowering it each time the unemployment rate breached their level and inflation did not materialize. This inability to predict inflation based solely upon the unemployment rate either means the economy has never reached NAIRU and/or there are other disinflationary forces at work. We believe both factors are in play and the Fed seems to agree with that conclusion. Therefore, rate hikes are unlikely until the Fed is confident that longer-term inflation dynamics have shifted up and they have confirmation that the economy and labor market have truly reached peak capacity.
Disparity in services versus consumer goods
The restrictions and lockdowns put in place in 2020 delivered unprecedented devastation to levels of output within service sectors, leading to services price inflation falling to a record low. While the consumer goods sector was also hit as a result of the pandemic, global core goods inflation has essentially seen a V-shaped recovery since the spring of 2020. This divergence has highlighted a distinct disparity between the consumer goods and service sectors, with services lagging significantly behind. It will likely be some time until we see the service sectors catch up and we do not expect a rapid rise in inflation until there is improvement in this area. While there may be pockets of near-term inflation from service sectors that have slashed capacity — travel and leisure come to mind — we do not see that materializing into longer-term inflation.
Lingering risks to a full economic recovery
There are risks to the anticipated economic recovery that we have yet to see play out. As of now, business restrictions and lockdowns are still in place across several regions in the U.S. and around the world. The recovery of the U.S. and the global economy in 2021 is in large part dependent on vaccine deployment or herd immunity combating the level of cases, hospitalizations and deaths to a point where restrictions are eased and things are back to normal. Until we see this fully play out, and see the projected economic boom unfold, we do not view inflation as a significant concern in the near term.
Inflation is a risk but not enough to derail markets
Inflation is certainly a factor for investors to keep in mind in 2021 and to follow more closely into 2022. A modest pickup in inflation should not be of great concern for policymakers nor prompt them to remove their accommodative policies. Additionally, inflation hasn’t historically been an issue for equities until it reaches above 3%–3.5%. We ultimately anticipate continued accommodation from policymakers and a modest rise in inflation within central bank tolerances to accompany the expected economic growth and recovery projected for second half of 2021. For these reasons, we remain constructive on equity markets and neutral duration.
This is not intended to serve as a complete analysis of every material fact regarding any company, industry or security. The opinions expressed here reflect our judgment at this date and are subject to change. Information has been obtained from sources we consider to be reliable, but we cannot guarantee the accuracy. This presentation may contain forward-looking statements. “Forward-looking statements,” can be identified by the use of forward-looking terminology such as “may”, “should”, “expect”, “anticipate”, “outlook”, “project”, “estimate”, “intend”, “continue” or “believe” or the negatives thereof, or variations thereon, or other comparable terminology. Investors are cautioned not to place undue reliance on such statements, as actual results could differ materially due to various risks and uncertainties. This publication is prepared for general information only. This material does not constitute investment, tax or legal advice to any party and is not intended as an endorsement of any specific investment. It does not have regard to the specific investment objectives, financial situation and the particular needs of any specific person who may receive this report. Investors should seek advice regarding the appropriateness of investing in any securities or investment strategies discussed or recommended in this report and should understand that statements regarding future prospects may not be realized. Investment involves risk. Market conditions and trends will fluctuate. The value of an investment as well as income associated with investments may rise or fall. Accordingly, investors may receive back less than originally invested.
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