The Bottom Line
- With markets suddenly volatile after years of calm, it’s easy to be distracted from the basics that drive prices long-term – like inflation.
- One key question now: Is inflation being driven by the threat of unsustainable wage growth. or are there more positive forces at work?
- Since the Great Recession of 2008-9, one key worry has been the sluggishness of corporations’ investment in productive capacity, which traditionally sets the stage for future growth.
- In the years immediately following the 2008-9 slowdown, companies made up for the pause in growth by rebuilding capacity. That boost showed up in inflation expectations – the most common measure, the 5-year breakeven rate, stayed between 2.5% and 3.5% until the latter part of 2015.
- As investment slowed down, inflation expectations fell as well – staying below the Fed’s medium-term 2% target rate.
- But as optimism, tax reform and expectations of a pickup in government spending all grew, investment picked up as well. Eventually, inflation expectations rose as well – with 5-year inflation expectations moving past 2 years in mid-January.
- Only time will tell whether the boost in investment will continue in the face of the currently unsettled financial markets.
- But it’s important to keep in mind that one of the underlying drivers of the pickup in inflation is in fact a positive for economic growth in the medium to long term
- It takes a fundamentals-based, active management approach to look past market volatility to focus on underlying economic trends, and to potentially put those trends to work on behalf of investors.