There were two barely noticed but significant comments on inflation in July – the first was the Fed removal of the suggestion that current low levels of inflation were transitory. Janet Yellen said:
“We are watching inflation very carefully, . . .I do believe part of the weakness in inflation reflects transitory factors, but well recognize that inflation has been running under our 2 per cent objective, that there could be more going on there.”
The Labor Department released July inflation figures today and they were indeed weak: overall consumer prices rose by 0.1% from June, putting them just 1.7% above their year-earlier level. Core prices (which exclude food and energy) were also up 0.1% on the month and 1.7% on the year.
The second was the suggestion by the ECB that a phasing out of asset purchases should not happen too soon. This was based on a conclusion, as expressed by Mario Draghi (President of the ECB), that “(b)asically, inflation is not where we want it to be, and where it should be.”
So why, despite a steady drumbeat of rising inflation expectations is the reality still falling short? It is clear that the Fed considered temporary factors such as the weakness in commodity prices before, but signs now are that there may be something more afoot. Certain managers we follow who track disruptive technology closely have warned of the deflationary impact of not only escalating technological advances – sectors such as healthcare as well as the auto sector are seeing costs collapse in certain areas. There is also the stubborn failure of wages to rise – despite falling unemployment levels the supply of cheap labor seems to be neverending. When this is combined with the fact that the “gig” economy has also acted as a deflator of wages there does not seem to be a turning point in sight.
These headline figures do mask unassailable increases in inflation in certain areas – education and housing to name but two. This suggests that “inflation hedging” strategies such as real estate, real assets and infrastructure could have a mixed outcome in the near term, as is certainly likely to be the case for commodities. The murky supply/demand picture for fuel as well as industrial metals and agricultural commodities is likely to de-link commodity returns from inflation for some time to come.
A manager we spoke with this week referred to the current era as one of “lowflation” – a persistently low inflationary environment. This would suggest that no particular investment strategy is suitable to offset it – nor is a “hedged” approach necessarily advisable. Perhaps a strategy that focuses on the different components of inflation – San Francisco real estate, rising healthcare insurance premia v. falling delivery costs in health care services that have been intermediated by technology, is a more suitable one for the era we live in.