Please see Celia Dallas and Joe Comras, “VantagePoint: Reflation, Inflation, or More of the Same?,” Cambridge Associates LLC, April 2021. For more on our views for 2022, please see “Outlook 2022: Flying at a Lower Altitude,” Cambridge Associates LLC, December 2021.
US consumer prices increased 7.0% year-over-year in December, which is the fastest annual rate since 1982, according to government data released today. We expect US inflation will moderate in the coming months, in line with consensus forecasts, but we anticipate it will settle in a higher range than the previous cycle. However, predicting future levels of inflation is notoriously difficult and positioning for inflation presents its own set of challenges. So, while we believe investors should be mindful of tail risks, they should aim to maintain well-constructed, diversified portfolios that are stress tested to protect against different macroeconomic outcomes.
Inflation has spiked, as extraordinary levels of stimulus have boosted demand for goods amid pandemic-related supply side bottlenecks. As a result, inflation for durable goods was 16.8% year-over-year, while inflation for services was steadier at 4%. But, there are signs that some supply side bottlenecks may be beginning to ease. For instance, US factories reported a softening in suppliers’ delivery times in fourth quarter 2021 and congestion at US ports has cleared somewhat in recent weeks.
Demand pressures may also be less acute this year, as measures of economic activity cooled in the second half of 2021. Given inflation is a lagging indicator, we expect slower growth will lead to slower inflation later this year. We’ve already seen some evidence of this slowdown in the second half of 2021. Inflation averaged 5.3% on an annualized basis in the last six months of 2021, compared to 8.8% in the first six months of the year.
While we expect inflation will ease later this year, it is likely to remain above levels that persisted during the previous cycle. US real GDP is expected to slow from 5.6% in 2021 to 3.9% in 2022, but it will remain comfortably above the 2% average rate of growth from 2010–19. And while policy rates are expected to increase by 75 basis points in 2022, they would still be highly accommodative and well below the Federal Reserve’s estimate of the long-run neutral interest rate of 2.50%.[1]The long-run neutral interest rate is the theoretical interest rate consistent with the economy maintaining full employment and price stability. Further, surging home prices and climbing nominal wages have supported household finances and spending, which in turn should support inflation.
In sum, while a deceleration in US inflation in the coming months seems probable, we expect it will settle in a higher range than the previous cycle. But key wild cards—including COVID-19, wages, and the Fed’s pace of tightening—exist.
TJ Scavone, Investment Director, Capital Markets Research
Footnotes