By Tim Courtney, Chief Investment Officer

Inflation has been a main focus for investors over the last few years. And as 2024 comes to a close with inflation cooling, do investors have to worry themselves about it anymore? We should listen to what the market is telling us about inflation, but also remember that markets don’t always predict the future correctly.

The first place we might look for clues about inflation is the bond market. The 10-year Treasury yield is currently at 4.2% while the 10-year Treasury Inflation Protected bond yields 1.9%.¹ The 2.3% difference between these bonds is what the treasury market believes inflation will be over the next decade,² which is not too far off of the 20-year average (2.5% annualized).

The Federal Reserve (Fed) also expects inflation to be tame over the next several years, roughly the same as the bond market in the low 2% range. Recently, however, inflation has run much hotter than what the Fed and the market had expected. In 2020, the Fed predicted that their preferred method of measuring inflation, the Core Personal Consumption Expenditure (core PCE) inflation would rise 2.3%, 2.2%, and 2.2% in 2021, 2022, and 2023.³ Actual PCE inflation was 4.9%, 5.1%, and 3.0%.⁴ The more widely followed and reported CPI inflation numbers were even higher at 7.0%, 6.5%, and 3.4%, respectively.⁵

From 2019 through 2024, the U.S. money supply (grown by Fed actions and federal spending) increased by over 30%, and 25% CPI inflation and 50% housing inflation were the results. The unique actions the Fed took in response to the pandemic are not likely to be repeated, but accelerating federal spending shows no signs of slowing. This plus the reshoring of supply chains and potential additional tariffs are inflationary, all else equal.

Some level of inflation is probably necessary for us to pay back our debts, which is easier to do with inflated dollars. This is how the U.S. paid for much of its World War II debt. From 1946-1951 inflation was 6.5% annualized while interest rates on government bonds were kept low.⁶ Remember those advertisements encouraging citizens to buy war bonds? Well, the bondholders ended up footing much of the debt through a 40% erosion in purchasing power. History shows inflation is a favored way for indebted countries to reduce their debt burden.

This doesn’t mean that we can’t have inflation return to a range of 2%. The market and the Fed may be correct, and we hope they are. AI could begin to pay off across wide sectors of the economy and the productivity benefits could help control prices. But there are also inflationary forces at work, and cash flow planning should account for an inflation rate that may be higher for longer. 

This means assuming a higher inflation rate than 2% in cash flow planning meetings with your advisor. It also means keeping a diversified portfolio that could better withstand higher inflation if it does come to pass. Inflation is falling, but the risk of it reaccelerating remains. As always, do not hesitate to contact your Exencial advisor with questions, and be sure to join the conversation: How are you preparing for potential inflation risks? Let us know on LinkedIn.

Sources:

1. CNBC (data as of 11/21/24) – U.S. 10 Year Treasury
2. WSJ.com (12/02/24) – Bonds and Rates, Yield on 10-Year Note, 7/15/2034 TIP Bond
3. Federal Open Market Committee (12/16/20) – FOMC Projections materials, accessible version
4. Federal Open Market Committee (12/13/23) – FOMC Projections materials, accessible version
5. DFA Returns 2.0 (12/02/24) – US CPI Inflation 2021 – 2023
6. Federal Reserve Bank of Chicago Economic Perspectives (10/2021) – Yield Curve Control in the US, 1942 – 1951

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