A moderate pickup in U.S. inflation is beginning to resonate with markets in 2018. As underlying inflation data has begun to pick up, market-based inflation expectations have approached 2%, nearing levels not seen since mid-2014. Recent year-over-year inflation measures such as core CPI (consumer price index) and core PCE (personal consumption expenditure) have nudged modestly upwards to 1.8% and 1.5%, respectively. Although these indicators fall below the Fed’s stated 2% inflation goal, these small moves represent a shift in momentum. Here we highlight two key factors facilitating this push. 

A tightening U.S. labor market has contributed to stronger inflation expectations. Over the course of 2017, the U.S. unemployment rate fell from 4.8% to 4.1% – well below the 5% rate that is often considered to be full employment. Declines in job vacancies tend to push wages higher as firms find it more difficult to recruit workers. Higher wages, a main input price of producing goods, result in higher costs for firms. The first indication of meaningful wage growth was seen this past month. In order to offset growing costs, businesses have to decide whether to increase prices in order to maintain current profit levels or implement cost reduction strategies (generally lay off workers). Given the strength of the current domestic economy, low unemployment, and solid GDP growth, economic indicators tend to signal potential for higher prices going forward. 

In addition to the tight labor market, a weaker dollar and signs of improving global economic growth have boosted commodity prices. Over the past eight months, the Bloomberg Commodity Index has risen 9.8% and the underlying pace of U.S. inflation continues to accelerate. While inflation has held below the Fed’s target, increasing commodity prices are one factor showing why policy makers are expected to continue raising rates in an effort to offset inflationary pressures. 

In order to combat rising inflation, Savant allocates a portion of its portfolio to inflation-adjusted bonds and commodities. Although stocks can provide the best hedge against inflation long-term due to higher expected returns, inflation-adjusted bonds and commodities can help protect against it in the short term. We believe it is imperative to incorporate as many different return streams as possible for your portfolio. Diversifying globally across assets that act differently across business cycles can help lead to a lower risk profile and the potential for higher returns.  

Read our complete January 2018 Economic & Market Commentary for Market Returns Year-To-Date, Market Returns Longer Term Annualized, Economic Indicators, and an Appendix.

Sources: Bureau of Economic Analysis (BEA), Federal Reserve, Morningstar Direct, Standard and Poor’s  

This is intended for informational purposes only and should not be construed as legal, investment or financial advice. Please consult your legal, investment and financial professionals regarding your specific circumstances.

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