In the longer term, inflation is currently not expected to rise much higher than what we see in 2017, Rehling adds, thanks to factors such as an aging demographic and high government debt levels. “Some people worry about high debt levels causing interest rates to rise, but they can actually be disinflationary because money has to be diverted from productive economic uses into servicing debt loads,” he says.
That diversion from production plays into another factor that may keep inflation in check — relatively slow growth. “Higher growth leads to inflation in its classical sense,” Rehling says. “We expect growth to continue at a modest pace.” The Federal Reserve projects 2% inflation in 2018 and in 2019.
Impact on stocks and bonds
What might a rising inflation rate mean for investors? “What I think is most important for investors to know is that as inflation ticks higher, interest rates are probably going to move with it,” McMillion says. “We believe the Federal Reserve likely will continue to increase interest rates as inflation approaches their target rate [2%]. We also believe bond market interest rates should also move higher over time to compensate for higher inflation levels.”
As bond yields move higher due to increasing interest rates, existing bond prices may move lower. “That’s something that many investors don’t always fully grasp: It’s an inverse relationship,” McMillion says. “Existing bond prices go down because new bonds are being issued at higher yield rates.”
Investors will still want to hold bonds, she says, because they provide a stabilizing component for a portfolio. But she suggests that most investors hold the majority of their bond investments in short-term or intermediate-term bonds — those within about seven years of maturity — which are less impacted by higher inflation rates.
Stocks, meanwhile, may benefit from the kind of moderate inflation that is expected. “Companies can often expand their profit margins a little bit when inflation is moving higher,” McMillion says, which typically has had a positive effect on the price of shares of that company’s stock.