3 Signs Inflation May Be Lurking Just Around the Corner
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After fits and starts and ups and downs, the American economy is finally looking strong — especially compared to Europe. U.S. gross domestic product grew 2.2% and 5% in the last two quarters of 2014, while the unemployment rate dropped in February to 5.5.%.
Yet inflation and wage growth, which are natural outgrowths of an accelerating economy, haven't seemed to materialize.
At least not yet.
Despite years of unconventional bond buying and warnings from politicians and economists, consumer prices have actually risen less than the desired rate of the Federal Reserve.
The Consumer Price Index declined 0.7% in January, the steepest drop since 2008, thanks to cheap oil. If you strip out volatile energy and food prices, so-called core inflation only rose 1.6% in January over the past year, well below the Fed's 2% target.
In fact, prices haven't hit that Fed target in almost two years. Your paycheck has hardly fared any better.
But lately, there have been signs that show America's workforce might at long last receive an overdue raise. About 70% of companies have said that wages are beginning to outpace inflation, according to the latest Duke University/CFO Magazine Global Business Outlook Survey. Industries like technology, manufacturing and health care should see wages grow by 3%.
A small business report points to a tighter labor force, as 26% of companies raised compensation (although that includes benefits like health care), and almost half said finding a qualified employee proved difficult.
What's more, the 10-year break-even inflation rate, which is a gauge of how much prices are expected to rise annually over the next decade based in part on the yield of 10-year Treasury inflation protected securities — has been ticking up lately to about 1.8%, after touching a recent floor of 1.5% in the beginning of the year. The rate, to be fair, is still well below levels seen before oil's drop.
So is inflation and wage growth finally set to take off?
That's a question for Federal Reserve Chair Janet Yellen, who has said the Fed will remain "patient" when raising short term interest rates while price growth remains so benign.
This six-year herky-jerky recovery has made fools of many prognosticators, especially those who have shouted loudly that inflation is nigh. "Given that CFOs expect continued strong employment growth, it is surprising that wage pressures are not even great," says Duke finance professor John Graham. Indeed.
What does this mean for your portfolio?
Well, one option is to add to your Treasury Inflation-Protection Securities (TIPS) holdings, especially short-term TIPS if you're a conservative investor (though this should still be only a satellite portion of your investments).
TIPS have struggled recently after outperforming equities by 11 percentage points in 2011, and investors have started to put their money elsewhere.
But the best time to get inflation protection is when there's little fear of rising consumer prices — and when inflation-protected bonds are cheap, like now. For instance, the Vanguard Target Retirement 2015 fund currently allocates about 8% of its portfolio to short-term inflation protection.