One thing that you can count on at the start of every new year is a fresh set of predictions from those of us in the investment business.
Last year, one of the most widely discussed and accepted views for 2017 was that the dollar would continue to gain strength, as it had for the previous three years. Instead, our currency lost about 10 percent, widely defying the consensus views.
This year, one of the most widely discussed and accepted views for 2018 is that inflation will rear its ugly head. At the depths of the 2008 financial crisis, many people (including me) thought that inflation posed a real risk thanks to the vast amounts of government stimulus.
When it became obvious a few years later that we weren’t headed for major inflation, the subject seemed to fall off of the radar for most people. That’s partly because inflation has been so tepid in recent years, mostly unable to meet the Federal Reserve’s target rate of two percent.
Now, though, some economists are starting to wonder aloud whether inflation may come back. The good news is that most individuals and businesses are confident that the economy is poised for higher growth after languishing at two percent since the crisis.
The bad news for people worried about inflation pressures is that the labor market is already tight with unemployment at 4.1 percent. If non-farm payrolls continue to grow at their recent pace and the size of the labor force stays roughly the same, it won’t be long before the unemployment rate is below four percent.
One of the most hotly contested concepts in economics is the Phillips curve, which attempts to show a relationship between lower unemployment and higher inflation.
Of course it’s more complicated than my one sentence summary and the data isn’t conclusive, especially in recent years. A growing number of people believe that the Phillips curve is dead, or that it never existed in the first place.
In addition, there is a third camp that believes that the relationship only holds when unemployment is really, really low. That’s the camp that is stirred up now because, as noted above, unemployment is really, really low and growth appears to be picking up.
I’m not really clever enough to have much of an opinion on the life and death of the Phillips curve, but I can’t say that I’m all that worried about inflation in 2018 at this point.
I mostly focus on market based expectations for inflation like the 10-year breakeven rate between Treasury Inflation Protected Securities (TIPS), which suggest that the bond market believes that inflation will remain around two percent a year for the next decade.
But my lack of concern, based on the bond market’s lack of concern, could, in fact, be the issue. The Phillips curve worriers are basically making the case that investors like me and the bond market aren’t worried enough about inflation.
It’s true that I may not be worried enough about inflation, but this is the point when I think back to the predictions from last year – about how the dollar was likely to rise in 2017 and then it fell, materially.
The reality is that no one knows what the new year will bring. As usual, I’m a little bit worried, but mostly excited. Of course there are risks, but there is also a world of opportunity. That’s my prediction for 2018.