(Bloomberg) – Some bond market bets signal that the inflation rate will fall near the Federal Reserve’s 2% target over the next year. A growing number of Wall Street asset managers say that’s a pipe dream.
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Fund provider VanEck sees inflation remaining stuck between 3% and 5% for many years, even if the United States falls into recession. Invesco says the market is too optimistic that an economic slowdown will dampen price pressures. Citigroup Inc. says it’s nearly impossible for inflation to slow while wage gains remain high.
Asset managers are keen to avoid a repeat of 2022, when the great minds of Wall Street were blindsided by both the sharp rise in inflation and the extent to which the Fed is expected to raise rates in response. Others are now joining BlackRock Inc., Bank of America Corp. and DoubleLine Group LP to warn that inflation will stay higher for longer.
“There are going to be ups and downs,” said David Schassler, head of quantitative investment solutions at VanEck, adding that a recession later this year could bring inflation down temporarily.
“What happens once the economy recovers? We believe inflation will rebound as it has in the past,” Schassler said. Rising energy prices will push up inflation, he added.
Since 1960, it has taken 12 years on average for inflation to slow to 2% or less once the US consumer price index broke the 5% mark, according to data compiled by VanEck. While the Fed’s focus is on the personal consumption expenditure price index, both numbers are being watched closely by the central bank and investors. Inflation based on the Bureau of Labor Statistics’ CPI has historically run about 0.3 percentage points faster than the Commerce Department’s PCE, with an even larger deviation during the pandemic.
The Schassler range for inflation refers to both measures.
It will be possible to bring inflation down to 3% by mid-2024 if a recession starts in the second half of this year, said Anna Wong, chief U.S. economist for Bloomberg Economics, citing both the IPC and PCE. But even staying at that level, let alone reaching 2%, will not be easy, as there is a limit to the continued decline in the prices of goods, services and housing, she said.
To prepare for years of persistent inflation, VanEck’s Schassler suggests ditching the traditional 60/40 portfolio. Instead, he prefers to allocate 50% to stocks, 35% to bonds and 15% to real assets, with an emphasis on gold and other commodities.
Invesco’s Jason Bloom also expects inflation – referring to both measures – to remain higher due to massive infrastructure spending in the US. Energy will likely become more expensive as the United States embraces alternatives to fossil fuels, said the firm’s head of fixed-income and alternative ETF product strategy.
Short-term Treasuries that currently offer higher yields will serve investors well as long as inflation persists, Bloom said.
Stuart Kaiser, head of U.S. equity trading strategy at Citi, said investors will stay defensive longer on a mix of large-cap tech, industrials and healthcare stocks, as well as a strong allocation to cash, while inflation persists.
“We haven’t seen a ton of evidence that inflation is going to go where the Fed wants it to go, which obviously means they should change their forecast and potentially increase further,” Kaiser said, pointing out the increase in the average hourly rate. results in April that he thinks the market has not taken into account.
Stock markets will be able to thrive even if inflation remains high, as long as it doesn’t take a stronger turn, he said. Economists at the firm expect core PCE to come in higher than the Fed forecast, he added.
Still, some investors think inflation could eventually slow to the Fed’s target. Liz Young, head of investment strategy at SoFi, said a recession could bring inflation down to 2% or lower, at least for a while. But the road to getting there could be brutal, she said.
“There’s a higher probability that something else will break than there is that inflation will go down and we’ll survive it unscathed,” Young said.
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