If we were to liken how inflation will evolve in the next 18 months to a novel, it’ll probably be a frustrating read, with a narrative that’s likely to unfold in fits and starts, accentuated by pockets of severe supply-and-demand imbalances and ongoing data distortions following the COVID-19 shock. There are, however, 10 key factors—or plot points, if you like—that we believe will shape the U.S. inflation outlook.
1 We expect U.S. inflation to evolve in three phases
First, we expect to see a sizable pop in the already relatively elevated Consumer Price Index (CPI) readings, beginning with April’s 4.2% year-over-year rise¹—which is likely to head even higher in May. Throughout the end of Q2 and into the beginning of Q3, we’re also likely to encounter ongoing upside surprises across a host of price measures, from import prices to prices paid indexes in surveys.
Second, the pace of inflation should then begin to slow meaningfully in late Q3 2021 and continue into 2022 as the mismatch in demand and supply begins to ease. The handoff from goods price inflation to services price inflation, which typically takes some time, should also feed into that narrative. Crucially, we also expect labor supply to improve by late Q3, which should mollify concerns about wage pressures. This period should confirm that sizable increases in headline inflation were, indeed, transitory.
U.S. inflation outlook: an overview
Finally, as we peer into 2023 and beyond, we see scope for slightly higher structural inflation (in the 2.0% to 2.5% realm versus the 1.5% to 2.0% range during the prepandemic period) as the delayed effects of higher shelter costs, infrastructure spending, lending activity, and medical costs translate into moderate longer-term price pressure.
Note that throughout our forecast period, we expect core inflation to remain below headline inflation (nearly all the time) and, crucially, within the U.S. Federal Reserve’s (Fed’s) average 2.0% inflation targeting mandate.
2 Supply chain disruptions
In our view, the biggest medium-term risk to inflation—the problematic kind that restrains growth and compresses margins—is ongoing supply chain disruptions, particularly in semiconductors, select commodities, and certain sectors such as used cars. Given limited precedence of supply chain disruptions of this magnitude, there’s no clear method to forecast or predict how or when these bottlenecks will be resolved; however, we believe these issues have the potential to be disruptive in certain pockets throughout 2021. That said, while supply chain disruptions may turn out to be stickier than initially thought, we expect the Fed to continue to label them as being transitory.
3 Inflation expectations
Current levels of market inflation expectations² and consumer surveys suggest market participants believe that near-term inflationary pressures are temporary in nature. If this continues, we should see limited pass through from inflation expectations to realized inflation and we wouldn’t expect consumer behavior to be particularly altered by inflation expectations.
In our view, the biggest medium-term risk to inflation—the problematic kind that restrains growth and compresses margins—is ongoing supply chain disruptions
4 A returning workforce could ease labor shortage
While there’ve been many anecdotal reports of business owners having to offer higher wages to attract staff, we’ve yet to see meaningful wage pressures. We expect labor supply to return to the market later in the summer, probably closer to September, when schools reopen and COVID-19 concerns are likely to have dissipated. Crucially, this is also when the federal government’s emergency employment aid programs expire. Until then, we’re likely to continue to see ongoing supply-and-demand mismatches in the job market that’ll encourage the view that sizable wage pressures must be imminent. Crucially, should the labor force supply fail to rise by then, it’s a sign that we could experience broad-based inflation in the following months—a key upside risk to inflation that warrants monitoring.
Small businesses say jobs are hard to fill, but don't plan on raising wages
Source: National Federation of Independent Business, as of May 28, 2021. The gray areas represent recession.
5 The velocity of money
It’s an economic truth: Money creation can produce inflationary pressures, but for that to happen, credit activity will need to rise meaningfully (or, put differently, money velocity needs to rise). In theory, as the economy heals, demand and supply and credit activity should improve. However, we question whether highly elevated levels of pent-up savings, when combined with the traditional structural increase in a higher level of precautionary savings, will reduce or delay the demand for credit from households. If we’re right, then money velocity will remain muted.
6 The impact of fiscal spending won't be as pronounced
While government spending is likely to continue to be sizable, the growth and inflationary impact of current stimulus measures are mostly front-loaded into 2021 and the first half of 2022. Crucially, data suggests fiscal multipliers for ongoing stimulus are low, meaning that they’re likely to have a comparatively muted impact on growth and inflation in the coming years. It’s just as important to remember that once the fiscal tap slows to a trickle later this year, the deceleration in fiscal spending will begin to weigh on real growth in 2022. Naturally, the proposed increase in infrastructure spending should have a positive effect on growth, but its impact on the real economy isn’t likely to be felt until much later. In our view, infrastructure spending is more relevant to longer-term inflation projections than in the short term.
7 The global inflation picture remains benign
The United States isn’t an island—U.S. inflation is heavily correlated to global inflation, which remains muted. Notably, Chinese credit trends are consistent with future weaker inflation in China, which tends to filter through to U.S. inflation through trade and global forces. Crucially, the relatively weaker U.S. dollar has been an important contributor to inflation in the United States and signs of further weakness will translate into higher import prices.
8 Goods price inflation versus services price inflation
Goods price inflation was a dominant feature of the COVID-19 recession. Higher prices were largely supported by rising household demand for goods (versus services) and higher commodity prices, which pushed headline inflation—but not core inflation—higher. We now believe the year-over-year inflationary impulse behind the factors driving goods price inflation are at or near their peak and that goods price inflation will slow as services price inflation begins to ramp up. For example, a closer look at the most relevant items in the CPI basket of goods shows that the cost of some items (household furnishing, used cars) have been major contributors to rising inflation while others (apparel, airfares) continue to face disinflationary pressures and have kept a lid on price levels.¹ As the economy reopens, these two groups of consumer items are likely to swap places and, on balance, should arithmetically move inflation lower.
However, this transition isn’t likely to be smooth and the lag between higher services prices and a relatively slower rise in goods prices is one reason by April, May, and June of 2021 inflation will likely remain high.
Goods price inflation outstripped services price inflation during the COVID-19 recession
9 A disconnect between U.S. house prices and rents
Shelter cost remains the single most important line item in the CPI basket. Crucially, shelter cost is calculated as rents in the CPI as opposed to house prices. Rents and home prices typically move in tandem, but their correlation broke down during the COVID-19 recession—largely because job losses during the period were disproportionally concentrated among renters versus home owners. As a result, rents fell as house prices rose. In our view, rents should begin to rise as the economy reopens and landlords find more pricing power; however, rises in rental charges tend to take place with a delay, meaning that rising rents are more likely to translate into inflationary pressures after 2022 than in the second half of 2021.
Key components in the CPI basket: price performance and rents
10 Keeping an eye on structural inflation dynamics
So far, we’ve focused on what’s likely to happen over the next 18 months, but we think it’s important to not lose sight of the bigger picture: longer-term inflationary and disinflationary dynamics. We continue to believe that in the long term, structural dynamics such as digitalization, demographics, productivity improvements, and higher debt levels are more powerful disinflationary forces than the inflationary pressures created by developments in climate transitions, deglobalization, and other geopolitical shocks. As such, from a strategic perspective, inflation is less likely to rear its ugly head, barring surprises. Then again, in a world that’s increasingly characterized by disruptions, nothing should be taken for granted.
Structural factors that could influence inflation in the long term
Source: Manulife Investment Management, as of May 13, 2021.
A widespread health crisis such as a global pandemic could cause substantial market volatility, exchange-trading suspensions and closures, and affect portfolio performance. For example, the novel coronavirus disease (COVID-19) has resulted in significant disruptions to global business activity. The impact of a health crisis and other epidemics and pandemics that may arise in the future, could affect the global economy in ways that cannot necessarily be foreseen at the present time. A health crisis may exacerbate other pre-existing political, social and economic risks. Any such impact could adversely affect the portfolio’s performance, resulting in losses to your investment.
Investing involves risks, including the potential loss of principal. Financial markets are volatile and can fluctuate significantly in response to company, industry, political, regulatory, market, or economic developments. These risks are magnified for investments made in emerging markets. Currency risk is the risk that fluctuations in exchange rates may adversely affect the value of a portfolio’s investments.
The information provided does not take into account the suitability, investment objectives, financial situation, or particular needs of any specific person. You should consider the suitability of any type of investment for your circumstances and, if necessary, seek professional advice.
This material is intended for the exclusive use of recipients in jurisdictions who are allowed to receive the material under their applicable law. The opinions expressed are those of the author(s) and are subject to change without notice. Our investment teams may hold different views and make different investment decisions. These opinions may not necessarily reflect the views of Manulife Investment Management or its affiliates. The information and/or analysis contained in this material has been compiled or arrived at from sources believed to be reliable, but Manulife Investment Management does not make any representation as to their accuracy, correctness, usefulness, or completeness and does not accept liability for any loss arising from the use of the information and/or analysis contained. The information in this material may contain projections or other forward-looking statements regarding future events, targets, management discipline, or other expectations, and is only current as of the date indicated. The information in this document, including statements concerning financial market trends, are based on current market conditions, which will fluctuate and may be superseded by subsequent market events or for other reasons. Manulife Investment Management disclaims any responsibility to update such information.
Neither Manulife Investment Management or its affiliates, nor any of their directors, officers or employees shall assume any liability or responsibility for any direct or indirect loss or damage or any other consequence of any person acting or not acting in reliance on the information contained here. All overviews and commentary are intended to be general in nature and for current interest. While helpful, these overviews are no substitute for professional tax, investment or legal advice. Clients should seek professional advice for their particular situation. Neither Manulife, Manulife Investment Management, nor any of their affiliates or representatives is providing tax, investment or legal advice. This material was prepared solely for informational purposes, does not constitute a recommendation, professional advice, an offer or an invitation by or on behalf of Manulife Investment Management to any person to buy or sell any security or adopt any investment strategy, and is no indication of trading intent in any fund or account managed by Manulife Investment Management. No investment strategy or risk management technique can guarantee returns or eliminate risk in any market environment. Diversification or asset allocation does not guarantee a profit or protect against the risk of loss in any market. Unless otherwise specified, all data is sourced from Manulife Investment Management. Past performance does not guarantee future results.
Manulife Investment Management
Manulife Investment Management is the global wealth and asset management segment of Manulife Financial Corporation. We draw on more than a century of financial stewardship to partner with clients across our institutional, retail, and retirement businesses globally. Our specialist approach to money management includes the highly differentiated strategies of our fixed-income, specialized equity, multi-asset solutions, and private markets teams—along with access to specialized, unaffiliated asset managers from around the world through our multimanager model.
This material has not been reviewed by, is not registered with any securities or other regulatory authority, and may, where appropriate, be distributed by the following Manulife entities in their respective jurisdictions. Additional information about Manulife Investment Management may be found at manulifeim.com/institutional
Australia: Hancock Natural Resource Group Australasia Pty Limited., Manulife Investment Management (Hong Kong) Limited. Brazil: Hancock Asset Management Brasil Ltda. Canada: Manulife Investment Management Limited, Manulife Investment Management Distributors Inc., Manulife Investment Management (North America) Limited, Manulife Investment Management Private Markets (Canada) Corp. China: Manulife Overseas Investment Fund Management (Shanghai) Limited Company. European Economic Area Manulife Investment Management (Ireland) Ltd. which is authorised and regulated by the Central Bank of Ireland Hong Kong: Manulife Investment Management (Hong Kong) Limited. Indonesia: PT Manulife Aset Manajemen Indonesia. Japan: Manulife Investment Management (Japan) Limited. Malaysia: Manulife Investment Management (M) Berhad 200801033087 (834424-U) Philippines: Manulife Asset Management and Trust Corporation. Singapore: Manulife Investment Management (Singapore) Pte. Ltd. (Company Registration No. 200709952G) South Korea: Manulife Investment Management (Hong Kong) Limited. Switzerland: Manulife IM (Switzerland) LLC. Taiwan: Manulife Investment Management (Taiwan) Co. Ltd. United Kingdom: Manulife Investment Management (Europe) Ltd. which is authorised and regulated by the Financial Conduct Authority United States: John Hancock Investment Management LLC, Manulife Investment Management (US) LLC, Manulife Investment Management Private Markets (US) LLC and Hancock Natural Resource Group, Inc. Vietnam: Manulife Investment Fund Management (Vietnam) Company Limited.
Manulife, Manulife Investment Management, Stylized M Design, and Manulife Investment Management & Stylized M Design are trademarks of The Manufacturers Life Insurance Company and are used by it, and by its affiliates under license..