The risk of deflation seems to have passed, and economists are now asking whether inflation will move above the Fed’s 2% annual rate target. Food and energy prices combined have an approximate 23% weight in the consumer price index (CPI), and of these two factors we think energy prices stand a chance of accelerating, particularly if the economy continues to improve and the U.S. does not exploit its abundant supplies of natural gas. Housing has a 40% weight in the CPI, and it is measured by two indexes of rents, not home prices. With fewer people owning homes nowadays, the demand for rentals has increased, and therefore rents have started to rise. If CPI inflation remains above 2% for long, look for the beginning of the end of the current period of very low interest rates. That could be unwelcome news for bondholders.
Nov 2011