Inflation scale
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If consumer demand is any indication, inflation could remain stubborn for at least the next 18 months, says Blerina Uruçi, chief U.S. economist in the fixed income division with T. Rowe Price.

“We’re probably not going to get to 2% on inflation until late 2025 or even early 2026,” she said. “We haven’t seen the degree of destruction in domestic demand that would bring inflation pressures down.”

Uruçi said “a Goldilocks outcome” for the U.S. economy, in which inflation comes down slowly and the economy remains resilient, would favour asset classes such as mortgages, where investors can benefit from both increases in value as well as positive returns from interest rates.

While it is tempting to build investment plans on hopes for the economy or the consensus view, she said that is a dangerous strategy.

“Oftentimes, the dominant consensus view is not the one that plays out, so we’re not keen to put all our eggs in one basket,” she said. “We try hard to think about why perhaps this time inflation pressures may not come down in as benign a way.”

If stubborn inflation prevents the Federal Reserve from cutting rates in the near term, she said, alternative strategies would become more attractive.

“We wouldn’t want to prematurely add duration,” she said. “We’d want to stay more on the front end of the curve, as well as explore opportunities in credit, and short-dated credit in particular.”

Uruçi advocates building portfolios with hedging properties in case inflation remains higher for longer. “Short-dated credit assets would perform well in this world,” she said.

She also likes inflation-linked bonds.

“I think this would be a good opportunity to start buying the dip and adding duration to portfolios,” she said.

Uruçi said the U.S. has been experiencing demand-pull inflation rather than cost-push inflation.

“Typically cost-push inflation is where you start getting worried about wage-price spirals,” she said. “I think we very much experienced demand-pull inflation, where demand is strong and firms are able to pass on price cost increases as well as maintain a healthy profit margin.”

Further, “as vacancies have come down and the labour market churn has slowed, we are also seeing wage inflation come down. And this is happening even as the unemployment rate hasn’t increased,” she pointed out. “Historically, you needed a spike in the unemployment rate to bring down wage inflation. So this … is further evidence that this is demand-pull inflation, not a wage-price spiral.”

Uruçi said the jury is still out on whether the persistent consumer demand in the U.S. is the result of a general insensitivity to high interest rates, or a dynamic shift in the U.S. economy where the equilibrium interest rate is higher than people think.

Either way, she said central banks around the world deserve credit for recognizing inflationary trends fairly quickly and moving appropriately to mitigate an escalating and complex problem.

“I would not give them a bad score. It was a very challenging time,” she said.

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This article is part of the Soundbites program, sponsored by Canada Life. The article was written without sponsor input.

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