Have We Turned the Corner on High Inflation?

July 19, 2023

In June, the 12-month Consumer Price Index inflation rate fell to 3% from 4% in May.  That’s down from the overall pace of 9.1% a year earlier,¹ but it’s a far cry from the sub-2% levels during the pandemic and the 2.2% average in the two decades leading up to 2022.²

Though inflation has slowed from last year’s blistering pace, we’re all still feeling the pressures of rising prices in our daily lives, whether at the supermarket, dining out, or planning a summer vacation. For some of us, this is the first real bout of inflation in our adult lives. For others, this scare may bring back memories of the early 1980s, the last time the loss of purchasing power was a front-burner issue affecting almost every financial decision, from what we invest in to where we park our cash to how we budget for retirement income.

The question is, will inflation remain at elevated levels for the foreseeable future? Or now that the Federal Reserve appears to be nearing an end to its year-long campaign of raising interest rates, can we expect inflation to fall back to modest levels of recent years?

The Economic Backdrop

There are a number of reasons why inflation could remain at higher levels than the Fed’s recent 2% target, though not at the extreme levels of 2022. For starters, supply chain problems, which were a major contributor to price spikes after the economy emerged from the COVID shutdowns, persist.³ While many snags in the global supply chain have abated considerably, challenges remain, exacerbated in part by the impacts from the war in Ukraine.

Meanwhile, worker productivity gains—which helped drive disinflation in recent decades—seem to have hit a wall lately. Output per worker has been flat or falling since 2020, and 2022 marked the first year since 1983 with three quarters of declines.⁴ Artificial Intelligence (AI) will likely enable future productivity gains, but the timing and scope is difficult to forecast.

Salaries have been climbing and wage pressures may persist for the next several quarters.⁵ In June, average hourly earnings grew 4.4% over the previous 12 months,⁶ well ahead of the 2-3% range prior during Covid.⁷ To be sure, the economy is slowing, which should alleviate some of that pressure. But the percentage of working-aged Americans in the job market has dropped from 67.3% in 2000⁸ to 62.6% today.⁹ Less labor participation is likely to push salaries higher for those in the workforce.

Given these structural changes—including the end of the era of globalization, which kept wages in check in recent decades—inflation is more likely to fall into the 3-4% range, as opposed to the 1-2% range to which we’ve grown accustomed.

What This Means

 Though we don’t expect extreme 1970’s style inflation to return, one thing from that era is likely to make a comeback: a healthy respect for rising prices and the need to factor inflation into a wide range of financial decisions. Back then, inflation was a key determinant in a wide range of decisions: what asset classes to invest in; how much to pay for those investments, and how to allocate across assets based on factors including risk-adjusted return potential, volatility, and the ability to outpace inflation over the long-run. Those considerations are likely to come back in vogue.

So, too, could the practice of viewing one’s finances in inflation-adjusted terms. This means thinking about real yields and real returns, and then adjusting retirement planning expectations and income assumptions, accordingly. It also means reconsidering what to spend on and how to budget, especially after leaving the workforce. We understand this seems like a complicated and involved process. If you would like to discuss the positioning of your strategy against this new inflationary backdrop, please reach out to me at queler@fiduciary-trust.com.

^{1 The Economics Daily, Bureau of Labor Statistics. July 18, 2022.} 

^{2 Historical Consumer Price Index for All Urban Consumers, Bureau of Labor Statistics.} 

^{3 “How Much Did Supply Constraints Boost U.S. Inflation?” Liberty Street Economics, New York Federal Reserve Bank.} 

^{4 “Worker Productivity Is Falling at the Fastest Rate in Four Decades,” CNBC.com, Dec. 18, 2022.} 

^{5 “Rapid Wage Growth Keeps Pressure on U.S. Inflation,” The Wall Street Journal. Aug. 9, 2022.} 

^{6 The Employment Situation, June 2023. Bureau of Labor Statistics, July 7, 2023.} 

^{7 The Pandemic’s Effect on Measured Wage Growth. Witehouse.gov. April 19, 2021.} 

^{8 “Labor Force Participation: What Has Happened Since the Peak?” Bureau of Labor Statistics, September 2016.} 

^{9 The Employment Situation, June 2023. Bureau of Labor Statistics, July 7, 2023.}