Two titans of the bond market are still clinging to the idea that inflation is going to make a comeback.
Time and again, weak economic data have made the market’s inflationistas -- many of whom were beguiled by President Donald Trump’s pro-growth promises -- look a little foolish.
But for Vanguard and BlackRock, it’s only a matter of months before inflation is back at 2 percent. Regardless of what does or doesn’t happen in Washington, a tight job market will boost wages, lead Americans to spend more and push up consumer prices. Add to that a weak dollar and prospects the Federal Reserve will hold off raising interest rates until 2018, and they see a good chance the bond market is too downbeat about inflation.
“The underlying trends in core inflation will be higher,” said Gemma Wright-Casparius, a senior money manager at Vanguard, which oversees $4 trillion.
Getting it right matters. Despite rock-bottom rates and trillions of dollars in quantitative easing by the Fed, inflation has been one indicator that’s stubbornly failed to return to levels consistent with a healthy U.S. economy. Inflation eased for a fourth month in June, dropping to an annual rate of 1.6 percent. The Fed’s preferred gauge was even weaker, slipping to 1.4 percent.
That’s made it more difficult for the Fed to unwind its easy-money policies, which a growing chorus of critics say have only succeeded in inflating the price of financial assets and left the central bank with little margin for error.
Fed officials, for their part, have repeatedly said the inflation slowdown is transitory, though they acknowledged in their July statement that price measures have “declined and are running below” goal.
To Wright-Casparius, the situation has left the bond market too pessimistic. As recently as June, bond traders saw inflation averaging less than 1.7 percent a year over the next decade. While last week’s strong job and wage numbers have helped to lift the market’s outlook (known as the break-even rate in bondspeak) to 1.8 percent, it’s still too low, she says.
Vanguard estimates 10-year break-even levels should be close to 2 to 2.25 percent. In July, she bought inflation-linked Treasuries, known as TIPS, which profit when inflation exceeds the market’s expectations. Wright-Casparius said she intends to add to those positions in the months ahead.
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