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

The growing debt burden of retiring Australians

More Australians are retiring with larger mortgages and less super. This paper explores how unlocking housing wealth can help ease the nation’s growing retirement cashflow crunch.

Four best-ever charts for every adviser and investor

In any year since 1875, if you'd invested in the ASX, turned away and come back eight years later, your average return would be 120% with no negative periods. It's just one of the must-have stats that all investors should know.

LICs vs ETFs – which perform best?

With investor sentiment shifting and ETFs surging ahead, we pit Australia’s biggest LICs against their ETF rivals to see which delivers better returns over the short and long term. The results are revealing.

Family trusts: Are they still worth it?

Family trusts remain a core structure for wealth management, but rising ATO scrutiny and complex compliance raise questions about their ongoing value. Are the benefits still worth the administrative burden?

13 ways to save money on your tax - legally

Thoughtful tax planning is a cornerstone of successful investing. This highlights 13 legal ways that you can reduce tax, preserve capital, and enhance long-term wealth across super, property, and shares.

Our experts on Jim Chalmers' super tax backdown

Labor has caved to pressure on key parts of the Division 296 tax, though also added some important nuances. Here are six experts’ views on the changes and what they mean for you.        

Latest Updates

Retirement

Why it’s time to ditch the retirement journey

Retirement isn’t a clean financial arc. Income shocks, health costs and family pressures hit at random, exposing the limits of age-based planning and the myth of a predictable “retirement journey".

Financial planning

How much does it really cost to raise a child?

With fertility rates at a record low, many say young people aren’t having kids because they’re too expensive. Turns out, it’s not that simple and there are likely other factors at play.

Exchange traded products

Passive ETF investors may be in for a rude shock

Passive ETFs have become wildly popular just as markets, especially the US, reach extreme valuations. For long-term investors, these ETFs make sense, though if you're investing in them to chase performance, look out below.

Shares

Bank reporting season scorecard November 2025

The Big Four banks shrugged off doomsayers with their recent results, posting low loan losses, solid margins, and rising dividends. It underscores their resilience, but lofty valuations mean it’s time to be selective. 

Investment strategies

The real winners from the AI rush

AI is booming, but like the 19th-century gold rush, the real profits may go to those supplying the tools and energy, not the companies at the centre of the rush.

Economy

Why economic forecasts are rarely right (but we still need them)

Economic experts, including the RBA, get plenty of forecasts wrong, but that doesn't make such forecasts worthless. The key isn't to predict perfectly – it's to understand the range of possibilities and plan accordingly.

Strategy

13 reflections on wealth and philanthropy

Wealth keeps growing, yet few ask “how much is enough?” or what their kids truly need. After 23 years in philanthropy, I’ve seen how unexamined wealth can limit impact, and why Australia needs a stronger giving culture.

Sponsors

Alliances

© 2025 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.