Page 10 - ISQ UK_October 2017

INVESTMENT STRATEGY QUARTERLY

“ The outlook for the coming year is likely to be even

more volatile with inflation and Federal Reserve
policy as the major factors. ”

ulation’s reluctance to accept vaccines, dampened the pace of 1980s. Union power was much stronger then and there is a greater
improvement in the third quarter. Growth was also restrained by concentration of large firms now. Wage bargaining power has
supply constraints, especially in motor vehicle production. shifted toward firms and away from workers over the last 40
Recent data suggest a rebound in growth in the fourth quarter. years. Still, the labour market is tight. Firms are reporting greater
difficulty in hiring and retaining workers, quit rates hit record
Supply chain difficulties occur in every economic recovery, but levels in the early autumn, and labour costs continue to rise.
the ongoing pandemic meant that repairing production and
transportation bottlenecks would take more time than usual. By Job growth was strong in 2021, although non-farm payrolls are
late summer, port delays in Southeast Asia and Southern Cali- still below where they were before the recession. Labour force
fornia contributed to a rough start to shipping for the holiday participation fell during the pandemic, reflecting dependent care
season. Supply issues were compounded by a surge in the issues and early retirements. There is even some recent evidence
demand for goods. During the pandemic, consumer spending of un-retirements (returning to the labour force after retirement)
shifted from services to goods. That shift was expected to unwind for those in their late 50s and early 60s. However, fewer older
as the service side of the economy improved, but it didn’t. Americans have gone into nursing homes during the pandemic
Spending on consumer goods has remained well above the and childcare is more expensive and less available. Labour force
pre-pandemic trend. participation has been trending flat over the last year.

Strong demand and restrained supply is a recipe for higher infla- It’s likely that higher wages will encourage a return to the work-
tion. Inflation picked up in the spring, partly reflecting ‘base effects’ force and slow the exit of older workers. President Biden’s Build
– a normalisation in prices that had been depressed a year earlier Back Better plan includes childcare support, but even if passed, it
– but there were restart pressures as well, especially evident in would take some time to implement. Beyond the short-term
prices of raw materials and in new and used motor vehicles. In the dynamics, the demographics of an aging population imply that
spring, the increase in inflation was narrow, concentrated in just a labour force participation should trend lower over time.
few components of the Consumer Price Index, but by October,
higher inflation was beginning to broaden across categories. FED POLICY

The Fed’s view was that inflation pressures would likely be transi-
WAGES AND INFLATION tory, meaning not permanent. However, the rise in inflation
Inflation expectations play an important role in the Fed’s policy expectations, continued supply chain strains, wage pressures,
outlook. It’s not so much that inflation expectations predict and the broadening of price increases is a worrisome combina-
actual inflation (they don’t), it’s that a mindset of higher inflation tion. The Fed recognises the risk of a more persistent increase in
becomes engrained. Workers are likely to demand better wages inflation.
and firms are more likely to try to raise prices. Near-term inflation
expectations have risen, but longer-term inflation expectations The Fed began to reduce (‘taper’) its pace of asset purchases in
have remained consistent with the Fed’s goal. November, lowering purchases of Treasury securities and mort-
gage-backed securities by $15 billion each month, but will
Wage inflation tends to follow price inflation, but (depending on accelerate that pace in January (taking purchases down to zero in
how easily firms can raise prices) higher wage inflation can rein- March of 2022).
force higher price inflation, creating a wage-price spiral. This is
the story we tell about the Great Inflation of the 1970s and early The Fed’s Large-Scale Asset Purchase program (LSAP, commonly
called quantitative easing or QE) was an important tool during

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