HH Is Inflation Making A Comeback?

In a noticeable turn of events, one of the key talking points for the 2017 investment landscape has been the potential return of inflation. Indeed, only a little more than a year ago, a rather different take on this topic was dominating market discussion: deflation. However, since the results of the U.S. election became known, market participants began to shift their focus to what is being referred to as the “Trump Reflation Trade.”

Quite simply, the logic behind this “trade” is that fiscal stimulus will now take the baton from monetary policy and provide a newfound jolt to the economy, spurring potentially higher growth and elevated inflation readings, accordingly. For the most part, the financial markets appeared to buy into this line of reasoning, as the S&P 500 has risen +10% since Election Day while the U.S. Treasury (UST) 10-Year yield has climbed by about 65 basis points (bps) during this same time frame. Interestingly, broader commodity prices, as measured by the Thomson Reuters/CoreCommodity CRB Index,  rose in the two-month period following the election to as high as +6.3% but have since reversed course and were basically unchanged as of this writing.

The most widely followed inflation gauge in the U.S. is the Consumer Price Index (CPI). This monthly report is released by the Bureau of Labor Statistics (BLS), with both the overall and core (excluding food and energy) readings receiving the most attention. 

The February CPI report revealed that overall inflation rose at a year-over-year rate of +2.7%, the highest in almost five years. This compares to the 2016 low point of +0.8% in July and the outright negative readings less than two years ago. Certainly, the rebound in energy prices from the levels witnessed 12 months ago played a role in this higher-than-expected reading, but perhaps more importantly from the Federal Reserve (Fed) perspective was the core measure, CPI minus food and energy, maintaining its recent upward pattern. Indeed, core CPI rose at an annual rate of +2.2% and has now posted a reading of +2.0% or higher for 16 consecutive months.