Markets & Economy
The global outlook on inflation
July 18, 2014
Catherine Gordon: We are seeing a recurring concern among investors about inflation globally. Joe and Roger, where do you think the global inflation risks are, if you think there are any at all?
Joe Davis: Well, you know, in terms of inflation risk it's certainly not one of my top three or five concerns at the moment. But let me amplify because I know others may disagree on that front. I think depending upon where you sit in the world, it's a different inflation experience. But broadly speaking, globally, the tension between inflation and the threat of higher prices versus deflation and the threat of falling wages, at best, it's balanced, and if anything, it's modestly disinflationary at the margin. You look at Europe, where the threat still is [that] prices could fall on a year-over-year basis. Japan has only very recently convinced the populace by and large that prices may actually rise next year, which is good to start to have positive inflation expectations.
And in China, at least at the margins, some of the inflationary pressures have ebbed. So the United States reported inflation measures are between 1% and 2%. I know for many listeners it may feel . . . higher, particularly if they drive or purchase food. And so I think the real frustration for many investors is that their wages may not be keeping pace with some of the rapid increases we've seen in food and energy prices. But broadly speaking, I think if inflation is going to accelerate in the United States, it's going to come in one area, and that would be in wage pressures, which is something that we are following closely.
So again, risk could increase or change going forward, but we sat here several years ago, Catherine, saying it was unlikely that reported inflation was going to drastically take off. And that's generally been the case. But we have to be vigilant in terms of the signals we monitor going forward.
Roger Aliaga-Díaz: Clearly, you want to be watching those upside risk in terms of inflation, right? But the reality is that the financial markets, the bond market [and] equity market, are pricing in this baseline scenario will not be different from what Joe is describing here, this 2% or 3% inflation in the major developed economies long term. And this is the type of inflation protection you already get with the traditional investments—with the nominal bonds, with equities, because that's what is embedded already in those prices.
Of course, some investors are more concerned [about an] inflation spike—surging inflation and that [could] happen within a year. And that's where having an appropriate allocation to a small amount of inflation-linked securities—TIPS in the U.S.—could help with that tail risk . . . having some sort of asset that is more sensitive to inflation in the short term.
Now, we remind investors normally that that is costly, too. I mean, when you invest in those assets, which are good for inflation protection, you give up yield and you give up return compared to a more normal bond, stock allocation. So there is an advantage and a disadvantage, a tradeoff, I would say, so it depends really on what you are worried about.
But if you are investing for the long term, for the ten-year horizon, which most investment goals and objectives cover—investments of that type—probably a traditional allocation may not be that bad with the . . . type of expectation for inflation we are having, with a baseline of 2% to 3% in major labor markets.
Catherine Gordon: Thank you.
All investing is subject to risk, including the possible loss of the money you invest.
Past performance is no guarantee of future returns. The performance of an index is not an exact representation of any particular investment, as you cannot invest directly in an index.
Be aware that fluctuations in the financial markets and other factors may cause declines in the value of your account. There is no guarantee that any particular asset allocation or mix of funds will meet your investment objectives or provide you with a given level of income.
Investments in stocks issued by non-U.S. companies are subject to risks including country/regional risk, which is the chance that political upheaval, financial troubles, or natural disasters will adversely affect the value of securities issues by companies in foreign countries or regions; and currency risk, which is the chance that the value of a foreign investment, measured in U.S. dollars, will decrease because of unfavorable changes in currency exchange rates.
Stocks of companies in emerging markets are subject to national and regional political and economic risks and to the risk of currency fluctuations. These risks are especially high in emerging markets.
Investments in bonds are subject to the risk that an issuer will fail to make payments on time, and that bond prices will decline because of rising interest rates or negative perceptions of an issuer's ability to make payments.
© 2014 The Vanguard Group, Inc. All rights reserved.
Two Vanguard economists discuss possible hints of inflation
In a short video, Chief Economist Joe Davis and Senior Economist Roger Aliaga-Díaz offer insights on whether higher inflation might be around the corner.
Also of interest:
- All investing is subject to risk, including the possible loss of the money you invest.