A Short Burst of Inflation, or a “Regime Change”? | Lord Abbett
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Economic Insights

What might history tell us about how long current inflationary pressures may last?

Read time: 2 minutes

Financial markets are trying to determine if the current bout of inflation is transitory—or the start of a “regime change” leading to a prolonged period of price increases. As is usual in uncertain times, investors are looking to comparable episodes in prior decades for guidance.

Channeling History

We have had short-lived episodes of inflation in the United States before. There were two bursts of inflation in prior decades that were the result of sharp increases in demand from one-time factors:

  • 1940s: The end of the rationing that took place for most of World War II and the release of forced savings.
  • 1950s: The military buildup associated with the Korean War and worries about another round of rationing.

Since the demand surge wasn’t sustained in either case, the U.S. economy downshifted, supply bottlenecks disappeared, and the sharp year-over-year price increases quickly reverted to much lower rates.

But there is an even better, and more contemporary analogy:

  • 2010-2012: The emergence of the U.S. economy from the global financial crisis (GFC).

Many observers expected that inflation would pick up, post-GFC, as large monetary and fiscal stimulus was deployed to foster economic recovery. And from late 2010 until early 2012, inflation did pick up, though it was nowhere near the historically high levels of the 1970s.

But as stimulus was removed, inflationary pressure eased, and the core consumer price index (CPI), which excludes food and energy prices, fell below 2% for most of the rest of the economic expansion—comfortably within the U.S. Federal Reserve’s target zone.

 

Figure 1. After Removal of Post-GFC Stimulus, Inflation Returned to the Fed’s Target Zone …Monthly core U.S. consumer price index, January 2007–April 2021

Source: U.S. Bureau of Labor Statistics. Data complied May 12, 2021. GFC=Global financial crisis of 2008–09. Fed=U.S. Federal Reserve. The core U.S. consumer price index excludes food and energy prices. For illustrative purposes only.

 

And the same thing happened, even more markedly, with a longer-term measure of inflation expectations; they came down sharply as fiscal stimulus and monetary accommodation were withdrawn.

 

Figure 2. ... and Investors’ Long-Term Inflation Expectations Fell Sharply

U.S. TIPS Five-Year, Five-Year Forward Breakeven Rate (monthly), January 31, 2007–April 30, 2021

Source: U.S. Federal Reserve Bank of St. Louis FRED database. This series is a measure of expected inflation (on average) over the five-year period that begins five years from today, based on the difference between the five-year U.S. Treasury rate and the five-year U.S. Treasury inflation-indexed security (TIPS) rate. GFC=Global financial crisis of 2008–09. For illustrative purposes only.

 

The Key Takeaway

We think the current belief that recent increases in key inflation indicators are transitory, and not part of a longer-term acceleration, is valid. We may indeed experience an inflation scare over the next six to 12 months, but if fiscal and monetary accommodation are rolled back—as they were in the post-GFC period—that brief jolt will end up being a false alarm.

 

The value of investments in equity securities will fluctuate in response to general economic conditions and to changes in the prospects of particular companies and/or sectors in the economy.

Forecasts and projections are based on current market conditions and are subject to change without notice. Projections should not be considered a guarantee.

This article may contain assumptions that are “forward-looking statements,” which are based on certain assumptions of future events. Actual events are difficult to predict and may differ from those assumed. There can be no assurance that forward-looking statements will materialize or that actual returns or results will not be materially different from those described here.

Treasuries are debt securities issued by the U.S. government and secured by its full faith and credit. Income from Treasury securities is exempt from state and local taxes. Although U.S. government securities are guaranteed as to payments of interest and principal, their market prices are not guaranteed and will fluctuate in response to market movements.

 

TIPS (Treasury Inflation-Protected Securities) are U.S. Treasury securities indexed to inflation in order to protect investors from the negative effects of inflation. The principal of a TIP is adjusted according to the CPI-U. With a rise in the index, or inflation, the principal increases. With a fall in the index, or deflation, the principal decreases. Though the rate is fixed and paid semi-annually, interest payments vary because the rate is applied to the adjusted principal. Specifically, the amount of each interest payment is determined by multiplying the adjusted principal by one-half the interest rate. Upon maturity, TIPS pay the original or adjusted principal amount, whichever is greater. Because TIPS are adjusted for inflation, a change in real interest rates (but not nominal interest rates) will affect the value of TIPS. When real interest rates rise, the value of TIPS will decline, and when real interest rates fall, the value of TIPS will rise.

The U.S. Consumer Price Index (CPI) is a measure that examines the weighted average of prices of a basket of consumer goods and services, such as transportation, food, and medical care. It is calculated by taking price changes for each item in the predetermined basket of goods and averaging them.

The information provided herein is not directed at any investor or category of investors and is provided solely as general information about our products and services and to otherwise provide general investment education. No information contained herein should be regarded as a suggestion to engage in or refrain from any investment-related course of action as Lord, Abbett & Co LLC (and its affiliates, “Lord Abbett”) is not undertaking to provide impartial investment advice, act as an impartial adviser, or give advice in a fiduciary capacity with respect to the materials presented herein. If you are an individual retirement investor, contact your financial advisor or other non-Lord Abbett fiduciary about whether any given investment idea, strategy, product, or service described herein may be appropriate for your circumstances.

The opinions in the preceding commentary are as of the date of publication and are subject to change. Additionally, the opinions may not represent the opinions of the firm as a whole. The document is not intended for use as forecast, research, or investment advice concerning any particular investment or the markets in general, and it is not intended to be legal advice or tax advice. This document is prepared based on information Lord Abbett deems reliable; however, Lord Abbett does not warrant the accuracy and completeness of the information.

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