It’s been nearly 3 years since inflation’s peak in June of 2022, when the US inflation rate neared double-digit territory for the first time in a generation.
While inflation has come down significantly since then, progress in reducing the rise of prices appears to have stalled, with some measures of inflation ticking back up in recent months.
Viewpoints sat down recently with Collin Crownover, PhD, the lead inflation analyst on Fidelity’s Asset Allocation Research Team, for a candid chat about his outlook. Here are excerpts from our conversation about where inflation may go this year, how much potential policy changes might move the needle, and why it’s not uncommon to see a “second wave” of inflation following an initial high-inflation period.
Viewpoints: What's your baseline outlook for inflation for this year and next?
Crownover: Putting aside any possible policy changes—my baseline outlook is that for the next few quarters US inflation may drift around about where we are now, at close to 3%. Then I see some risk that inflation moves higher later on in the year, and there are a couple of reasons for that.
One is that the labor market is still chugging along quite well, and in fact workers are finally starting to see good gains in their wages after accounting for inflation. That’s not a bad thing, but it means people have more purchasing power. By the latter part of the year, they may start spending some of that extra money, creating inflationary pressure.
The second is that the Fed has cut its policy rate by a full percentage point over the past several months. Although on its face the Fed’s policy rate may look high, the economy isn’t behaving as though interest rates are that high, and so the recent reduction in rates might add to inflationary pressures. Changes in rates tend to impact the economy at a lag, which is why I think that could also be something to watch for in the latter part of the year.
Viewpoints: In addition to those broad drivers, what’s going on under the hood with some of the key components of inflation?
Crownover: There’s good news and bad news under the hood.
The good news is that I believe housing inflation may continue to soften. I don’t think it will come down to low levels, but I believe it will come down from the roughly 4.5% it has been running at to something like 4% or slightly lower. In part that is just due to the mechanics of how housing inflation is calculated—it feeds through with a long lag. And in part it’s a reflection of new construction of multifamily homes, which is helping to relieve supply pressures in the rental side of the market. Now, only about 20% of the housing stock is multifamily—the rest is single family. So we still have a housing shortage in the US, but there is some relief on the rental side.
The bad news is I believe prices of goods will be heading back up, as some of the last effects of the pandemic finally normalize. Here’s an example: During the pandemic you couldn’t get new cars, so consumers turned to used cars. Used cars then became in short supply and went up significantly in price—for some cars by as much as 40%. But there was no reason for those prices to stay so high once supply went back to normal. Last year, we saw goods prices falling in many categories as as supply-induced price increases were unwound. Now, however, I think that normalization has finished. If goods prices are done falling, then they won’t be offsetting inflation from other sources anymore, and instead they will be contributing to inflationary pressures again.
Viewpoints: Turning to policy, how great of an impact do you expect new tariffs might have?
Crownover: It’s important to distinguish between the tariffs that have taken effect and those that are on pause. So far the 10% incremental tariff on China is the only new tariff that has taken effect. Tariffs on aluminum and steel are expected to take effect in March, while the tariffs that were announced on Canada and Mexico are currently on pause.
I do not believe the tariff on China is going to move the dial on inflation to a noticeable degree. China is an important trade partner, but it’s not our biggest trading partner—it’s actually only our third largest.
Our largest trading partners are Canada and Mexico, which is why the paused tariffs could have a greater potential impact should they go into effect. My rough estimate is that if the suspended tariffs go into place, the US inflation rate could increase by 0.70 of a percentage point.
That said, it wouldn’t happen on day one. And to understand how the impacts might be felt you have to look at what the US imports from those countries. One impacted area might be the auto sector. The Detroit auto manufacturers are closely integrated with auto-parts suppliers in Ontario. Aside from Detroit, many cars sold in the US are manufactured in Mexico. Another impacted area might be energy. Some US oil refineries are specifically built to refine the heavier tar sands oil that comes out of Canada. So those refineries would either pay a higher price for Canadian tar sands oil or shut down. Canada is also a significant exporter of lumber into the US, so construction costs could be another area to watch.
Viewpoints: Are there other areas of potential policy change that could meaningfully impact inflation?
Crownover: Yes. There could be a positive offset to these inflationary pressures from some of the work on reducing regulation and improving efficiency. For example, suppose you can reduce the length of time it takes to obtain a federal permit to drill for oil—which takes almost a year on average and sometimes much longer, contributing to what can be a 10-year delay in bringing oil to market. Reducing that essentially makes it cheaper for the oil company to bring that energy to market, and it also means that more supply can come to market faster. As that example shows, however, there is a time lag to experiencing those potential benefits.
The other area is immigration policy, which can have both inflationary and disinflationary pressures. Removing workers from an already-tight labor market will tend to push wages up and may add to inflationary pressures. On the other side, removing those additional consumers from the economy may, all else equal, put downward pressure on prices.
Viewpoints: There are a lot of unknowns in the outlook, but bringing it all together, do you think we need to worry about a return of the painful inflation we saw a few years ago?
Crownover: It looks highly unlikely to me. That surge that we suffered through was really due to a confluence of unusual events hitting all at once. The pandemic was affecting supply chains, the federal government was handing out stimulus payments, and at the same time monetary policy was very loose. I’m not seeing the harbingers of extremely loose policy like we saw during the pandemic, which is what it might take to hit that level of inflation again.
Now, historically, it has been common in the US and other developed countries that after an initial surge of inflation subsides, there is a second wave. The best-known example was in the 1970s. It can happen because inflation looks like it’s under control, and so policy is loosened a bit, only to find out inflation wasn’t quite beaten yet.
But often a second wave is not as severe as the first. Could we go from around 3% today back up to 4%? I believe yes, absolutely. But I believe it’s highly unlikely that we would go back to the high single digits.
Viewpoints: What might continued inflationary pressures mean for investors?
Crownover: At these levels of inflation, investors may get less diversification benefit from holding a traditional mix of stocks and bonds in their portfolios. The diversification benefit isn’t eliminated, but it is diminished.
This means investors might want to consider assets that provide inflation protection or diversification. Two such examples are commodities and TIPS (Treasury Inflation-Protected Securities). Both of those have historically outperformed during periods of higher inflation. They could potentially help investors better weather an inflationary backdrop that looks different from recent pre-pandemic history.