Is U.S. inflation on the rise?

Staying ahead of inflation is a must for investors. Question is, will investors soon have to run faster than usual to maintain their edge?

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Strong economic data in the U.S. could mean rising inflation is around the corner for Americans. Earlier this year, the IMF revised its forecast for U.S. GDP to 2.7% from 2.3% for 2018, and to 2.5% from 1.9% for 2019. Revisions were based on U.S. tax reform.

But not everyone sees rising inflation when they look at the firming data.

“We’ve been hearing more murmurs lately from economists about U.S. inflation,” says Robert Abad, product specialist at Western Asset Management in Pasadena, Calif. “Our inflation outlook differs from the consensus.” His firm co-manages the Renaissance Multi-Sector Fixed Income Private Pool.

During the last few years, he’s found that the market had been “overly optimistic” about U.S. growth and inflation momentum—especially at the start of the year.

“So far 2018 is no different,” Abad said during a late March interview.

In addition to stateside tax reform, U.S. economic data tied to wage growth and jobs claims have bolstered the rising inflation narrative.

However, says Abad, “We don’t see the latest tax bill as inflationary, nor do we believe that Fed policy has been conducive to rising inflation.” He adds that the latter has failed to jumpstart the necessary growth for sustainable inflation, which is evident from the Fed’s preferred measure for annualized inflation, core PCE.

Read: Fed raises key rate, expects two more 2018 hikes

That measure failed to reach 2% during Fed Chair Janet Yellen’s four-year term, says Abad, who adds, “Long-term inflation expectations, as measured by forward-looking market indicators, are still around 2%.”

The Fed isn’t alone in its failure to achieve its 2% inflation target. “The European central bank and the Bank of Japan have been very aggressive in trying to raise core inflation to the 2% bar—and without success,” he says.

Economy still slacking

Abad sees a U.S. economy with further slack throughout 2018, as well as economic data that suggest a deceleration in spending and inflation.

“The slack primarily comes from [recent] spending patterns,” says Abad, referring to downward-trending indicators for money supply and credit growth. Such data indicate “banks are very cautious still,” he adds.

“Only a certain number of consumers are able to get credit.”

As a result, “We don’t see enough velocity of money, or money moving around the economy, in a way that would suggest broader participation—or broader spending—which ultimately would lead to more economic activity.”

Together, these economic factors support his view that “the low-inflation world we inhabit isn’t going to change any time soon.”

Read: U.S. economic growth in Q4 revised upward to 2.9%

Picking up the slack

Despite the sluggishness of the U.S. economy, there’s no room for slacking off when it comes to portfolio positioning and inflation risk, which is “a key driver of interest rate risk,” says Abad.

Read: How to adapt portfolios to today’s challenges

“We’re always monitoring economic data, not just in the U.S. but globally, to ensure that we have enough buffers in our portfolio against a sudden and sharp rise in interest rates.”

His global multi-sector strategy allows for diversification across a number of countries and sectors to take advantage of differences in growth, inflation and interest rate cycles, he says.

For example, “We have a bullish view on intermediate-maturity Treasurys, given our view of subdued U.S. inflation and growth, as well as current valuations,” says Abad.

“However, we also have a bearish view on longer-maturity German government bonds, as we see growth momentum in that region moving higher. That could spark more upward pressure on inflation and ultimately lead to higher interest rates.”

Overall, his outlook is for a slowly recovering global economy and for central banks to gradually withdraw stimulus. “But it’s not a sure thing by any stretch,” he says.

Read: Aging population has reduced monetary policy’s effectiveness: C.D. Howe

If his outlook proves broadly correct, he says bonds in the high yield, bank loan and emerging market spaces should do well. All of those are “key total return drivers of our global multi-sector strategy,” he adds.

“If there are any meaningful wobbles along the way, we believe our Treasury bonds should help provide a cushion against the spread risk in our portfolio,” Abad concludes.

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