Tags: Feldstein | inflation | Fed | rates

Feldstein: 'Inflation Will Head Higher in Year Ahead'

By    |   Tuesday, 02 June 2015 09:00 AM

Inflation has vexed the Federal Reserve, staying far below its 2 percent target despite the central bank's massive easing effort.

Consumer prices slid 0.2 percent in the 12 months through April, and the Fed's favored inflation gauge, the personal consumption expenditures price index, rose just 0.1 percent in the 12 months through April.

But Fed policymakers needn't worry for long, says Harvard economist Martin Feldstein, chairman of President Reagan's Council of Economic Advisers.

"Inflation will head higher in the year ahead," he writes in an article for Project Syndicate.

"Labor markets have tightened significantly, with the overall unemployment rate down to 5.4 percent, [a seven-year low.] . . . As a result, total compensation per hour is rising more rapidly, with the annual rate increasing to 3.1 percent in the first quarter from 2.5 percent in 2014 as a whole."

Falling energy and import prices are compensating for the impact of higher wages. "But, as these temporary influences fall away in the coming year, overall price inflation will begin to increase more rapidly," Feldstein argues.

"If inflation rises faster than the Fed expects, it may be forced to increase interest rates rapidly, with adverse effects on financial markets and potentially on the broader economy."

Meanwhile, now that Fed Chair Janet Yellen has said the central bank will likely raise interest rates later this year, what effect will rising rates have on your investment portfolio?

The history of interest-rate hikes offers us some guidance, says Joshua Brown, CEO of Ritholtz Wealth Management.

"This is because the predominant variable of the markets — human behavior — doesn't change very much from generation to generation, even if the environment around us does," he writes in an article for Fortune.

Brown and Ritholtz Research Director Michael Batnick looked back at the eight rate-hike cycles since 1976. This is what they found:
  • "U.S. stocks: surprisingly resilient as interest rates rise;
  • "International stocks: the special ingredient that keeps performance on track;
  • "U.S. bonds: not nearly as bad as you think;
  • "Diversified portfolio: this is how you win."
In the eight periods, "there have been zero instances where this diversified portfolio has produced a negative return," Brown explains. "The worst compound annual growth rate for the diversified portfolio was 0.5 percent from February to October 1987."

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Inflation has vexed the Federal Reserve, staying far below its 2 percent target despite the central bank's massive easing effort.
Feldstein, inflation, Fed, rates
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2015-00-02
Tuesday, 02 June 2015 09:00 AM
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