Register For Our Mailing List

Register to receive our free weekly newsletter including editorials.

Home / 205

From deflation fears to inflation worries

Over the past three years, inflation expectations have come full circle, falling significantly in mid-2014, rebounding from a low in February 2016, and stabilizing in 2017. Contrary to some market commentary, we believe that the US economy has reached the point where the risk for inflation is substantially tilted to the upside.

This shift to an environment in which inflation may return to more normal levels has important implications for investors. An allocation to real assets can protect against inflation and diversify a portfolio while generating current income and offering capital appreciation.

 

Emerging inflationary pressures

Measures of core inflation (which excludes volatile energy and food prices so more accurately reflects underlying inflation) gradually began to rise in the second half of 2015, as the US economy continued its long recovery from the GFC. The year-on-year change in the core Personal Consumption Expenditures (PCE) price index (the preferred measure of the Federal Reserve) rebounded from a near-term low of 1.3% in July 2015 to 1.8% in February 2017. The year-on-year change in the core Consumer Price Index (CPI) rose as well, from 1.6% in December 2014 to a range of 2.0%–2.3% over the past year.

This acceleration in inflation has been slow in part due to the plunge in oil prices and the rapid strengthening of the US dollar, but the recent rise in core inflation roughly coincided with the fading base effects of low oil prices and rising import prices.

The acceleration in US wage growth is evidence that cyclical pressure is building, as labour markets tighten and the economy nears potential. The year-on-year change in average hourly earnings bottomed at 1.5% in October 2012 and has since risen to 2.7%. Rising wages also broadened in the last two years. Unlike in the early 2000s, when workers at the top end of the wage scale experienced the strongest gains while workers with lower income experienced none, recent data shows a meaningful increase for nearly all income levels.

A strengthened global economy also is providing support, as highlighted by the International Monetary Fund, which recently reaffirmed its view that the global economy will grow more rapidly and more broadly across developed and emerging economies in 2017.

We believe we have reached an inflection point for inflation. Deflation risks have been replaced by rising inflation expectations and, based on cyclical factors alone, we believe inflation of 2.0%–2.5% is likely. Furthermore, there is structural risk from a possible backlash against globalisation, which could lead to protectionism and higher prices. In this scenario, inflation could exceed 3.0%.

 

Hedging against inflation

Given this risk, investors should revisit their portfolios to ensure they have assets that can protect against inflation. Inflation can corrode purchasing power even at moderate rates. A 0.25% month-on-month increase in the CPI, or about 3% annualised, compounds to around 15% loss in purchasing power over five years.

Thirty years ago, investment options were limited, mainly to gold and large cap equities, but today’s investors can hedge against inflation while also maintaining their investment plans. Because inflationary pressures are likely to be relatively moderate, investors should consider assets that also offer capital appreciation or income. Thus, investors can be ‘paid to wait’ if inflation is dormant. These include real assets – real estate, commodities and infrastructure – as well as inflation-linked bonds and equities with ‘pricing power’. Key features of these inflation-hedging assets include:

 

 

  • Real estate, which includes rental apartments, businesses, and office complexes, can offer stable cash flows because many have lease structures in place.

 

  • Commodities contribute to headline inflation, and have historically outperformed equities and bonds when inflation rises.

 

  • Infrastructure assets are positively correlated with inflation because they tend to consist of monopolies (e.g., bridges, toll roads, airports) with few alternatives for consumers, giving the ability to maintain margins by passing on price increases.

 

  • Inflation-linked bonds provide a real yield for investors by contractually linking inflation to principal and interest payments. When issued by government entities, they are usually seen as low-risk diversifiers.

 

  • Companies with pricing power enjoy sustained demand for their product or service, passing on price increases to customers without losing market share. Equities also offer exposure to growth, and may provide returns even if inflation is dormant.

 

Liquid versions of these assets offer the added benefit of flexibility, allowing for allocation changes in response to different manifestations of inflation. For example, real estate would benefit from rapidly rising property prices and rents. Commodities would benefit if the US dollar weakened. Infrastructure would benefit from fiscal stimulus targeting increased infrastructure spending.

 

Ron Temple is Managing Director and Portfolio Manager/Analyst at Lazard Asset Management. This document is for informational purposes only and does not constitute an investment agreement or investment advice. All opinions expressed herein are as of the date of this article and are subject to change.

  •   8 June 2017
  • 1
  •      
  •   

RELATED ARTICLES

Why a deflationary shock is near

Investing across deflation, inflation and stagflation

Are we again crying wolf on inflation risk in pandemic response?

banner

Most viewed in recent weeks

Testamentary trusts post-budget: Estate planning, tax reform and the ‘death tax’ debate

Proposed Budget changes to taxation are casting new uncertainty over testamentary trusts, prompting closer scrutiny of estate planning structures and the real implications of reforms still taking shape.

How to minimise tax with a will

Inheritance tax implications in Australia may surprise some, as poor estate planning without proper wills or trusts can lead to costly tax bills and delays for beneficiaries.

Meg on SMSFs: The CGT changes don’t impact super but what about Div 296 tax decisions?

New CGT rules could tip the scales in the super vs non-super debate. For those facing the Division 296 tax, the case for withdrawing has gotten more complex. A "comparison rate" tool may help assess decisions.

High quality businesses are on sale

Beneath the dominance of the ASX's largest stocks, much of the market has been left behind. High-quality companies are now trading at levels rarely seen, offering opportunities for investors willing to look deeper.

The strange effect of the 30% minimum capital gains tax

The 30% minimum tax on capital gains sits at the heart of the budget's proposed reforms. Yet the mechanics reveal anomalies that introduce unexpected distortions that raise questions about its design.

Welcome to Firstlinks Edition 667 with weekend update

The downfall of the giant and three lessons for investors.

  • 18 June 2026

Latest Updates

Latest from Morningstar

Ranking three common retirement strategies

The defining challenge of retirement isn't just about building wealth, it's about converting your lifetime savings into sustainable income. A holistic understanding of different strategies can improve long-term outcomes.

Economy

Was life really better in the good old days?

Are we worse off than previous generations? Lately, there seems to be a heightened level of angst that economic conditions are getting harder and that the two-party political system (and maybe democracy too) is failing voters.

Retirement

Australia has saved $4.5 trillion for retirement. Here's what matters more

Most Australians approaching retirement can tell you the exact dollar value of their super account. But success depends on more than a sizeable balance. Here's four key questions to ask yourself at the start of the financial year. 

Who gains in an AI-supercharged economy?

AI is already reshaping the economy, but companies building transformative technologies rarely capture the greatest long-term value. Instead, those benefits accrue to the users. We may well see this pattern reproduced. 

Taxation

Div 296's million-dollar reset worth $25,000

The 'cost base reset' for the new super tax is being sold as protection for pre-July gains. A worked example shows $1M of protection is worth about $25,000, and the real deadline has not passed.

Latest from Morningstar

The forecasting fix that Wall Street missed

Asking whether markets are overpriced may be the wrong question. New research suggests that traditional valuation metrics used to forecast returns may have been misread. Here are five takeaways for investors.

Investment strategies

Should a fund manager invest their own money differently?

Investors often like the idea that fund managers should invest client money exactly as they invest their own. But reality is more complicated. Unique circumstances make a different approach rational and, at times, beneficial.

Sponsors

Alliances

© 2026 Morningstar, Inc. All rights reserved.

Disclaimer
The data, research and opinions provided here are for information purposes; are not an offer to buy or sell a security; and are not warranted to be correct, complete or accurate. Morningstar, its affiliates, and third-party content providers are not responsible for any investment decisions, damages or losses resulting from, or related to, the data and analyses or their use. To the extent any content is general advice, it has been prepared for clients of Morningstar Australasia Pty Ltd (ABN: 95 090 665 544, AFSL: 240892), without reference to your financial objectives, situation or needs. For more information refer to our Financial Services Guide. You should consider the advice in light of these matters and if applicable, the relevant Product Disclosure Statement before making any decision to invest. Past performance does not necessarily indicate a financial product’s future performance. To obtain advice tailored to your situation, contact a professional financial adviser. Articles are current as at date of publication.
This website contains information and opinions provided by third parties. Inclusion of this information does not necessarily represent Morningstar’s positions, strategies or opinions and should not be considered an endorsement by Morningstar.