Economic Flash: Slow Labor Market Keeps Lid on Inflation, Rates

June 2021

US Economy: Rising prices.

The Fed’s preferred inflation gauge, Core PCE, rose 3.1% year-over-year, slightly faster than analyst expectations. Short-term supply disruptions as the economy reopens are one aspect driving the acceleration. Still, forward-looking measures such as the 10-year breakeven interest rate (2.5%) suggest inflation could remain elevated.

US Stocks: Value over growth.

With economic data largely meeting expectations, both large and small US equities posted modest returns in May marked by the ongoing trend of value stocks outperforming growth stocks. Energy (+9.0%), materials (+6.5%) and financials (+5.4%) were the market-leading sectors.

Foreign Stocks: Strong results.

Both the emerging and developed markets outpaced US equities in May. While China was positive, smaller global index components and countries that have been under the radar for the last 12 months, such as Hungary (+16.0%) and Poland (+13.7%), were the standouts.

Fixed Income: Inflation and flat rates?

Despite inflation expectations and Fed meeting minutes indicating a willingness to curb bond purchases later this year, US interest rates fell a few basis points in May, with the 10-year US Treasury yield resting below 1.6%. Weaker manufacturing and job creation data were contributing factors.

Real Assets: Mixed results.

Commodities in general continued their recent runup due to sourcing shortages and higher global demand, but returns were disparate. For example, while gold (+7.7%) and oil (+4.5%) each saw price increases, agricultural commodities such as wheat (-9.7%) and corn (-2.5%) fell on easing concerns over supply.

Alternatives: Uncorrelated strategies in favor.

Assets in hedge funds rose above $4 trillion, the highest level on record. Inflows into fixed-income-based strategies continued, but hedge funds long on stocks are seeing outflows, as investors look to lock in profits given equity valuations that seem stretched by some historical measures.

Equities Total Return

U.S. Large Cap 0.7% 12.6% 40.3%
U.S. Small Cap 0.2% 15.3% 64.5%
U.S. Growth (1.5%) 6.2% 40.5%
U.S. Value 2.4% 19.0% 46.3%
Int’l Developed 3.3% 10.1% 38.4%
Emerging Markets 2.3% 7.3% 51.0%

Fixed Income Total Return

U.S. Agg. Bond 0.3% (2.3%) (0.4%)
TIPS 1.2% 1.1% 7.1%
U.S. High Yield 0.3% 2.3% 15.2%
Int’l Developed 1.1% (4.3%) 4.6%
Emerging Markets 2.1% 0.4% 10.0%
Intermediate Munis 0.1% 0.3% 2.8%
Munis Broad Mkt 0.4% 1.0% 5.3%

Non-Traditional Assets Total Return

Commodities 2.7% 18.9% 46.2%
REITs 0.8% 18.1% 32.2%
Infrastructure 0.6% 7.2% 23.8%
Hedge Funds
Absolute Return (0.3%) 1.7% 7.3%
Overall HF Market 0.3% 3.2% 13.4%
Managed Futures 1.9% 7.6% 12.4%

Economic Indicators

MAY-21 NOV-20 MAY-20
Equity Volatility 16.8 20.6 27.5
Implied Inflation 2.5% 1.8% 1.2%
Gold Spot $/OZ $1907 $1777 $1730
Oil ($/BBL) $69 $48 $35
U.S. Dollar Index 111.3 114.4 122.9

Glossary of Indices

Our Take

With over 40% of the total US population fully vaccinated and more than 1 million doses being administered daily, we continue to expect a return to normalcy this summer. While some recent US economic data have been less robust than anticipated, in aggregate they still point to an economy growing faster than usual.

The focus for investors remains on the inflationary consequences of rapid growth, which have begun to present themselves in the data. While inflation has recently accelerated by most measures, a shortage of workers is putting a damper on new job creation and could act to contain price pressures. The labor shortage could dissipate relatively soon, however, as enhanced unemployment benefits end and workers feel safe to return to work post-Covid.

At this point, we think inflation will remain elevated and US interest rates are likely to resume their rise, but not to a problematic degree.

What We’re Doing

Our decision to maintain a higher stake in equities following the market recovery in 2020 has been rewarded. That said, we continue to look for ways to improve diversification in client portfolios and to protect from potential headwinds due to rising tax rates and inflation.

While we always maintain some inflation-countering exposure to real assets such as REITs, commodities, and infrastructure, we are making sure we are prepared should inflation accelerate more quickly or in a unique way relative to history. For example, the proliferation of renewable energy sources could keep a lid on energy prices, a key component of inflationary pressures in the past.

Another focus area is research and development to further our sustainable investment platform. We have provided sustainable investing solutions for more than 20 years and we continue to work to advance the analytical tools and evaluate new investments so that clients can be confident their portfolios meet both their financial objectives and reflect their values.