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ECONOMIC FLASH – Where’s the Inflation?

October 2017

US Economy: Growth yet stubbornly low inflation.

The US economy grew 3.1% in the 2nd quarter, revised from 2.7%, on higher inventory restocking. However, core inflation is only 1.4%, contradicting the “growth-with-inflation” outlook of the Fed.

US Stocks: Small stocks surge.

Small-cap equities outperformed, partly due to their operational focus on the US market and the expectation they would benefit more than large stocks from a potential cut to the corporate tax rate.

Foreign Stocks: Emerging markets lag.

Despite upbeat economic data from China and others, geopolitical concerns and higher US interest rates pushed the dollar upward, chipping away at emerging market returns. Brazil (+4.2%) and Russia (+4.3%) bucked the trend due to rising oil prices.

Fixed Income: Treasury yields spike.

Bonds struggled as the 10-year US Treasury yield (2.3%) rose to its highest level since July on signs the Fed will raise interest rates in Dec. and also the potential for tax reform to fuel inflationary growth.

Non-Traditional: Oil continues Q3 rebound.

The world price of crude oil rose nearly 20% in Sept. and finished just below $58/barrel due to geopolitical tensions and improving global demand.


The Trump Administration’s tax reform proposal boosted equities on expectations that a lower corporate tax rate would support higher profit growth. However, actual tax reform seems uncertain given that the proposal includes non-starters for many Democrats as well as Republicans.

In equities, we continue to evaluate whether our portfolios may benefit from more defensive positioning as we head into Q4. In that vein, we recommend reducing or eliminating REIT positions, which face significant headwinds from rising interest rates, higher valuations, and the changing dynamics of retail (20% of REITs are retail-dependent).

In fixed income, we expect Federal Reserve actions to negatively impact pricing for most bonds (selling of fixed-income securities on Fed balance sheet starting in Oct. and the likelihood of another interest rate hike in Dec.). However, we think the Fed will continue to clearly communicate its plans, which should keep volatility subdued.

Glossary and Disclaimer for Economic Flash

Equities Total Return

U.S. Large Cap 2.1% 14.2% 18.6%
U.S. Small Cap 6.2% 10.9% 20.7%
U.S. Growth 1.6% 20.4% 21.9%
U.S. Value 3.3% 7.7% 15.5%
Int’l Developed 2.5% 20.0% 19.1%
Emerging Markets (0.4%) 27.8% 22.5%

Fixed Income Total Return

U.S. Agg. Bond (0.5%) 3.1% 0.1%
TIPS (0.6%) 1.7% (0.7%)
U.S. High Yield 0.9% 7.0% 9.0%
Int’l Developed (1.5%) 7.4% (4.8%)
Emerging Markets (0.7%) 8.5% 1.8%
Intermediate Munis (0.6%) 3.7% 1.0%
Munis Broad Mkt (0.4%) 4.6% 1.0%

Non-Traditional Assets Total Return

Commodities (0.1%) (2.9%) (0.3%)
REITs (0.8%) 6.0% 2.6%
Hedge Funds
Absolute Return 0.7% 3.3% 2.9%
Overall HF Market 0.6% 4.4% 5.6%
Managed Futures (2.1%) (2.8%) (6.5%)

Economic Indicators

SEPT-17 MAR-17 SEPT-16
Equity Volatility 9.5 12.4 13.3
Implied Inflation 1.9% 2.0% 1.6%
Gold Spot $/OZ $1280 $1249 $1316
Oil ($/BBL) $58 $53 $49
U.S. Dollar Index 87.5 94.5 90.1

Our Take