Is Inflation Rising Persistently, or Is It a Short-Term Blip?

Most market watchers believe this is going to be a year of robust growth, and they cite many reasons: the reopening of worldwide economies as Covid vaccinations progress, pent-up consumer demand and continued global monetary and fiscal support of monumental proportions. Asset inflation is surging in many areas. Equities have generally been performing well. Bonds, on the other hand, may be challenged, although investors favor fixed-income securities for their diversification benefits.

In this uncertain landscape, Western Asset holds an out-of-consensus view about the potential path of inflation.

We are keeping an open mind, but our bottom line is that we are not convinced there will be a persistent, year-over-year increase in inflation, nor significant rate increases.

We heard 10 years ago that rates and inflation were going up. Five years ago, inflation was supposedly going up again. It was not true then, and while we do think it’s more likely now, we still don’t see a sustained rise in inflation over the short term. Our view here is based on several factors, including substantial slack in the labor market, low nominal GDP growth and the current state of bank lending.

We agree that, in the short run, inflation will likely go higher, mostly because of the so-called base effects. A year ago, as we were dealing with the onset of the global pandemic, we saw very weak inflation prints. The worry then was deflation, not inflation. So just the year-over-year comparison from these very low levels will show inflation rising.

Now we believe short-term inflation could be well in excess of the U.S. Federal Reserve’s annual target of 2%. Yet in his recent appearance before the Senate Banking Committee, Fed Chair Jerome H. Powell suggested the economy has a long way to go before reaching 2% inflation.

“The economic recovery remains uneven and far from complete, and the path ahead is highly uncertain,” Mr. Powell said in his prepared remarks. “Although there has been much progress in the labor market since the spring, millions of Americans remain out of work.”