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Our Asset Allocation Committee Thinks Short-Term Inflation is Unlikely

Sébastien Page, CFA, Head of Global Multi-Asset

Executive Summary

Our asset allocation portfolios have an underweight allocation to inflation-sensitive equities. In our view, short-term inflation is unlikely given that money supply typically inflates asset prices more than goods prices, the Fed may not be able to overshoot the 2% target inflation, and secular forces against inflation may endure.


Due to stimulus measures, money supply has just jumped more than it ever has over a one-year period. Meanwhile, the Fed has announced that they will focus much more on driving unemployment lower and keeping it low, than keeping inflation below 2%. They’re throwing away some of their old models that predict that you’ll see inflation when unemployment gets too low. Moreover, the Fed will now target 2% on average, which signals that they’re willing to let inflation go above 2% for a while.

So, should we worry about inflation risk? Strategically—meaning from a long-term perspective—our portfolios include inflation-linked assets, including allocations to a diversified portfolio of inflation-sensitive stocks. But we’re not too worried about inflation over our tactical horizon. We are underweight inflation-sensitive assets relative to our strategic asset allocation.

Here are three reasons not to worry about inflation risk over the six- to 18-month horizon:

  • First, money supply typically goes into asset price inflation more than goods inflation. What drives inflation is when the economy runs at capacity, with low unemployment and high GDP growth, which is the opposite of current conditions. 
  • Second, the Fed may not be able to overshoot. PCE was above 2% for only four quarters over the last expansion. So four quarters out of 10 years. So, I’m a runner but I can’t run six-minute/mile. I can target five-minute/mile all I want in order to average to six-minute/mile, but it won’t happen because I can’t. 
  • Third, the secular forces against inflation are real—think automation (reducing pressures on labor costs), digitization and technology (driving costs of goods down over time), and think globalization (the ability to buy cheap goods manufactured outside the U.S.).

Over the last 10 years, the Fed has implemented low rates, quantitative easing forever, we’ve poured fiscal gasoline on top, and…we have not seen inflation.

The bottom line is that long-term investors may need some form of inflation protection to maintain purchasing power over time, but as tactical asset allocators, we have underweighted our inflation-sensitive assets.

Morningstar Awards 2020©. Morningstar, Inc. All Rights Reserved. Awarded to T. Rowe Price for 2020 U.S. Morningstar Exemplary Stewardship and to Jerome Clark for 2020 U.S. Morningstar Outstanding Portfolio Manager, U.S.A.