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Weekly Market Analysis: Why US Inflation is Unlikely to be like the 1970s
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A New Normal for Interest Rates
Even as we still expect yields to moderate in the coming year, we would prefer to describe the 2022-2023 surge in interest rates a “normalization” rather than an “overshoot.”
Both the double-digit yields of 1980 and zero yields of 2020 appear to be historical aberrations.
US Inflation Today is Unlike the 1970s
The 1970s was a decade of lasting monetary accommodation and negligence as inflation expectations accelerated (peaking near 10% in 1980). Today, long-term consumer inflation expectations hover near 3% even after supply shocks reminiscent of the 1974 OPEC embargo.
The US Fiscal Policy Focus is Different Compared to the 70s
Comparisons to the 1970s are not wholly “right or wrong.” US fiscal policy has retrenched only partially after the massive spending increases of the pandemic.
Federal spending has switched emphasis to security, infrastructure and competitive issues that are more lasting. Securing redundancy in supply chains is unwinding some disinflationary benefits of globalization.
Summary
When it comes to economic history, many have sought to describe where we are now as a 70s throwback. The inflation of the 70s was mighty, mighty, but is the present déjà vu more than a feeling? In 2021 and 2022 we have suffered inflation averaging nearly 7% in the US and higher in some regions. In the 1970s inflation ran at 8% for 10 years.
So, are we entering a period like the 70s or are we exiting a period of unusual, non-systemic dislocations? With current bond yields roughly half of their upwardly-trending 1970s levels, should we be worried?
We do not see a return to sustained 1970’s-style entrenched and accelerating inflation. Our reasons include large monetary policy differences, major shifts in global dynamics and the rise of information for consumers as a contributor to more competitive pricing.
Portfolio considerations
Even as we still expect yields to moderate in the coming year, we would prefer to describe the 2022 surge in interest rates a “normalization” rather than an overshoot. Both the double-digit yields of 1980 and zero yields of 2020 appear to be historical aberrations. The Giobal Investment Committee call on short- and intermediate term Investment Grade Fixed Income and US Treasuries remains.
Source: Haver Analytics, September 7, 2023. All forecasts are expressions of opinion and are subject to change without notice and are not intended to be a guarantee of future events. Indices are unmanaged. An investor cannot invest directly in an index. They are shown for illustrative purposes only and do not represent the performance of any specific investment. Index returns do not include any expenses, fees or sales charges, which would lower performance. Past performance is no guarantee of future results. Real results will vary.
A New Normal For Interest Rates
We believe the widespread fear that we are in the midst of is a repeat of the 1970s period of rising inflation and eroding asset prices is misplaced. Notably, such fear is not priced into markets. US Treasury Inflation Protected Securities embed a 10-year average 2.3% gain for the Consumer Price Index. Meanwhile, the S&P 500 trades at 20X this year’s likely profit. Even as we still expect yields to moderate in the coming year, we would prefer to describe the 2022 surge in interest rates a “normalization” rather than an overshoot.
US Inflation Today is Unlike the 1970s
Among the strongest drivers of “70s deja-vu” has been the increase in labor union activity, political emphasis on unions by the US administration and high-profile labor actions. This coming week, the United Auto Workers threatens a strike at one or more of the “big-3” auto producers. According to the Wall Street Journal, Ford Motor company has offered workers a 9% wage increase over 4 years. The Union of Auto Workers asked for a 46% increase.
The US auto industry has been in a period of recovery from critical parts shortages this year and is only now beginning to satisfy unmet demand from 2021-2022. Labor friction amid technology revolutions (like electric vehicles) are just one reason why we don’t emphasize investments in industries that are capital-intensive, cyclical and undergoing structural realignments.
While far from unimportant, the US autos industry has been diminishing as a share of economic activity. A potential strike would have an impact on regional growth measures, but is very unlikely to be decisive for the economy as a whole. The larger story of union power and strikes has mostly followed the same course. The perception of severe labor action might seem high, yet the number and scale of labor disputes and strikes has stayed dramatically lower than the 1970s, as has union participation.
Overall, US labor costs have indeed gone up recently. But the gap between higher wages and falling profits is most similar to 2015, not 1975. Wage payments are decelerating presently to a 5.6% year over year pace. This is about half the 10.3% average pace of the 1970s.
The US Fiscal Policy Focus Is Different
The Fed is not following its 1970s course of neglect and the belief that higher inflation “greases the wheels of commerce.” As the world public has certainly experienced the ugly side of inflation over the past two years, policy has tightened. The Fed has been convincing markets that it intends to see inflation curtailed to normal levels by 2024-25. Only recently, markets have come to the view that a recession might not be needed to achieve this.
In 2020, monetary and fiscal policy created a short, sharp burst in inflation, larger than at any time in the 1970s. US broad money growth was 25% that year. But unlike the 1970s, the burst of monetary stimulus is not being sustained. It is being reversed. US broad money (M2) has contracted 3.7% over the past year, the first annual decline since the late 1940s.The Fed has swerved hard to convince the public that it is willing to risk a recession to contain inflation. As a consequence, long-term consumer inflation expectations and much consumer behavior suggests a marked difference from the 1970s. Present consumer long-term inflation expectations hover at 3%, not far above the pre-COVID period.