Global Fixed Income Strategy Aug 2017

Monthly insights and updates from the Invesco Fixed Income team.

Aug 31, 2017 | Invesco Fixed Income

Why is inflation surprisingly low?

Over the past five months, the US has experienced a string of surprisingly low inflation reports. After peaking at 2.7% in February, annual growth in the Consumer Price Index (CPI) dropped steadily to 1.7% by July. More importantly, “core” inflation, which removes the volatile food and energy components, fell from 2.2% to 1.7% over the same period. Because core inflation is an important determinant of bond prices and US Federal Reserve (Fed) policy, we believe it is important for investors to understand what drives it and how it is likely to evolve in the future.

There are two main drivers of core inflation

  • The first bucket is volatile core prices. These prices (mostly for goods, such as autos and apparel) tend to be driven by both global and domestic supply and demand, commodity prices and the US dollar. Prices of these goods fluctuate widely, but also tend to return to trend, or “mean revert,” fairly quickly.
  • The second bucket is “sticky” core prices that are resistant to change. These are typically for services (such as housing and health care) that are driven mainly by domestic supply and demand. These prices are generally more stable due to less influence from global price pressures. During the post-crisis recovery, sticky core prices have been supportive of overall rising US inflation.

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