Hello, I'm RJ Gallo, Senior Portfolio Manager, Federated Hermes.
What's your outlook on inflation?
The inflation outlook is not a return to the 1970s. Sometimes I think people fear that it is, and we at Federated Hermes have a range of views. It's interesting to me that those who are closer to 60 seem to fear a return to the inflation of the '70s, early '80s. Those who are younger than 40 are not worried about it at all. I'm between those age ranges, and so I'm in between those two in terms of my worry about inflation. I think bond investors hate inflation. It erodes the value of their fixed coupon payment and thus diminishes their real return. If bond investors fear a surge in inflation, bond prices must fall, yields must rise, and potentially rapidly. That isn't happening. It's not happening in part because I think the Fed has convinced many in the market, probably some of those who are 40 years and younger, that the current inflation surge is in fact transitory, the remnant of the reopening of the economy from the pandemic. And there is some truth that the price increases being somewhat transitory.
I'm sure that's going to be the case. We believe on the other hand, it won't be as transitory and it won't be as muted ultimately as Fed Chair Powell suggests it will be. The surge in prices has not just been this year versus the same time last year. You're seeing it month on month. The rapid reopening, the large fiscal stimulus, the very accommodative monetary policies across the globe are starting to fuel upward trajectories of inflation that ultimately I think will surprise. They'll be higher and a little longer than the Fed would like. That does not return us to the late '70s. We don't need to summon the ghost of Paul Volcker to vanquish double-digit inflation, but I wouldn't be surprised at all if we see inflation rates that are well above two. I'm talking two and a half, three, three and a quarter, three and a half. Right now they already are on a year-over-year basis, but some of that is temporary. As time goes by, I think the bond market is going to be disabused of the notion that this is all temporary, and I think the bond market will reprice accordingly, with yields being somewhat higher, not a tantrum, not a spike, but somewhat higher to compensate for the risk of inflation being a little bit more than the Fed had hoped.
Disclosure: Views are as of June 22, 2021, and are subject to change based on market conditions and other factors. This should not be construed as a recommendation for any specific security or sector. Investments are subject to risks and fluctuate in value. Bond prices are sensitive to changes in interest rates, and a rise in interest rates can cause a decline in their prices. Federated Investment Management Corp. 21-10103 (7/21)