Inflation Doesn’t Seem Ready for Liftoff

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The inflation rate should be an important consideration for investors. It not only affects the price of many investments—particularly those such as bonds which provide fixed periodic payments—but also how much money you need to reach your financial goals. But for all its importance the inflation rate hasn’t moved dramatically in recent years, and it doesn’t seem likely to start doing so any time soon.

The most commonly used measure of the inflation rate, the Consumer Price Index, was a measly 0.1% in the year through June. That’s far below the Federal Reserve’s target rate of 2% (the Fed technically uses a different measure of inflation, but their measure isn’t much higher). Part of the reason for the low inflation rate has been the plunge in the oil price, which has fallen by about 50% during the past year. But even the inflation rate based on the “core” Consumer Price Index, which excludes food and energy prices and therefore tends to bounce around less, is only 1.8%. It hasn’t touched 2% since early 2013, and it hasn’t touched 3% in almost 20 years.

When will this long period of low inflation end? To gauge financial markets’ expectations about what the inflation rate will be in the future, economists often use “breakeven rates,” which compare regular bonds to inflation-linked bonds. These currently suggest that the inflation rate will remain low, averaging less than 2% per year over the next 10 years.

Such numbers won’t necessarily prove correct, and investors who are concerned about a sudden surge in the inflation rate could use the current period of sanguine expectations to cheaply buy protection against higher inflation (for example with inflation-linked bonds). Yet there are good reasons to think that the inflation rate will remain subdued. Janet Yellen, the Fed chairwoman, recently said that the Fed remains on track to raise interest rates this year. If the Fed starts raising interest rates even as global economic growth continues to slow, the inflation rate may go down rather than up.  

Topics: Inflation