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Solloway economic outlook 2Q22 mid-year review

July 15, 2022
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- Hi, I'm Heather Corkery, managing director of Client Portfolio Management at SEI. Today, I'm here with chief market strategist and senior portfolio manager, Jim Solloway, who will be presenting our economic outlook for the coming months. Jim, it's been our mantra for the past year that inflation would be higher for longer than most economists and investors appeared to expect. Has the gap between our expectations and those priced in markets narrowed?

- Yes, considerably. That said, investors still seem to be betting that inflation pressures will ebb significantly starting in the second half of this year and fall to 3% by the end of 2023. This is a concern because the Federal Reserve is hanging its hat on the apparent stability of investors' inflation expectations in the longer run. If these expectations were to rise, it would force the central bank to get even more aggressive acin tightening monetary policy than it currently projects.

- How do you see inflation developments evolving?

- We have a somewhat more pessimistic view, with inflation perhaps settling at levels higher than those expected by the Federal Reserve and implied in break-even rates. We also think that price increases might continue to surprise on the upside in the near term. Although, the rate of change in the consumer price index or CPI and other measures of inflation are almost certainly close to a peak. Look no further than the trends in sticky and flexible prices for reasons to expect higher inflation to stick around. The U.S. CPI can be divided into two categories: products and services that tend to historically have sticky or persistent price trends and items that have much more flexible and volatile prices, gyrating up and down in a relatively short cycle. Think of housing-related costs as an example of sticky prices, while fuel and electricity costs are good examples of flexible prices. The flexible CPI has been on a sharp upward trajectory for more than a year. But of even greater concern is the behavior of the sticky CPI. Its ups and downs have been quite muted since the mid-1980s, but price increases have been accelerating in a relentless fashion since January 2021, reaching a peak of more than 5% in May. That is the highest level in more than 30 years. The annualized rate of gain in the sticky CPI over the past three months has been even sharper, amounting to 6.8%.

- Seeing these levels in what's supposed to be the stable subset of CPI certainly supports the higher for longer case. We can't really conclude a review of the inflation landscape without looking at the labor market, though, right?

- Agreed. The labor market remains exceptionally tight. Until a better balance between the demand and supply of labor is achieved, we should expect further large wage gains at the lower end of the wage income spectrum where the job market is tightest. American job switchers have enjoyed a sharper than average wage gain of 7.5% over the past 12 months. This helps explain why the U.S. quit rate is significantly higher than in 2019 or at the previous economic peak in 2007. Other major developed economies aren't too far behind. United Kingdom has an unemployment rate below 4%. Canada and Europe usually have unemployment rates that are considerably higher than the U.S. and the UK, which remains the case, but both report jobless totals that are below previous cyclical lows. All this suggests that the workers are in a strong position to seek bigger wage gains in an effort to keep up with inflation. The possibility of a global wage-price spiral still cannot be dismissed out of hand. This could force central banks to raise interest rates more than they would prefer.

- Thanks, Jim. As your OCIO, SEI is focused on the impact inflation has on our clients. We incorporate these discussions into our advisory process as the impact varies based on each client's goals. For more of SEI's insights, read our latest economic outlook, available on our website.

Glossary

An OCIO, or outsourced chief investment officer, is a service provided by investment managers to institutional investors. OCIOs can provide investment advice, risk management, decision making, delegation or execution of tactical and strategic investment processes, and fiduciary accountability.

Index definitions

The Consumer Price Index measures changes in the price level of a weighted-average market basket of consumer goods and services purchased by households. A consumer price index is a statistical estimate constructed using the prices of a sample of representative items whose prices are collected periodically.

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