Inflation Expectations – Up or Down?

After an ugly close to 2018, the financial markets have leapt off to a strong start in the new year with the S&P 500 up almost 7% year-to-date. While many of the economic issues that lagged the market are still unresolved, the bulls are running on Wall Street again.

It’s amazing that in just 20 days, the market has gained back all of last year’s losses. The Fed is signaling they won’t be as aggressive with interest rates and there is hope for a quick trade deal with China. Other issues, like the government shutdown, are taking a sudden back seat.

What has really caught my eye recently is this chart I snapped from the Wall Street Journal last week. I couldn’t find it online, so I’m including this somewhat fuzzy picture I took on a plane. It shows how much inflation fears have subsided in just a few months …

Last year, like a lot of folks, I started worrying that we were heading into a more inflationary time. I wrote THIS POST about it before the midterm elections. I even went back and looked at our early retirement assumptions for retirement.

I use a 2.5% annual inflation assumption, so we were still in a ‘safe’ place on that variable, but I worried because retirement assumptions are incredibly sensitive to changes in the inflation rate. If inflation stays a half a percent below our target we are golden. That said, if inflation moves a half a percent above our target (to 3%), it will be painful if investments don’t keep up.

Fortunately this WSJ forecast for inflation over the next ten years has moved back below 2%. I imagine it will start moving back up at some point, especially given that oil prices (which are a highly volatile component of CPI) are in the doldrums right now, but likely to recover before too long.

What inflation assumptions have you used in your FIRE model?

Image Credit: Chart from WSJ, 4 Jan 2019; Pixabay

9 thoughts on “Inflation Expectations – Up or Down?

  1. What inflation assumptions have you used?
    Our assumption is that any gains in the market will be wiped out by inflation so we don’t rely on it for spending. What are your assumptions for growth in the stock market?

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    1. We’ve planned 5% for capital gains (7.5% has been 30 year market average) and an additional 1.5% for dividends. I try to keep all of our assumptions on the conservative side so that we have ‘buffers on our buffers’.

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  2. Hey Mr. Fireman,

    I currently use 2% which is a little low. Your 2.5% is probably more realistic. I did read an interesting article recently that showed how average expenses for those over age 70 did start a long term trend downward. I know the conventional wisdom is that increased health care costs will consume any other decreases. However, the data on average expenses doesn’t back up the CW. Thanks for the update.

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    1. I think a component of corporate earnings are – price increases that cover rising costs of commodities or labor. In that sense stock prices reflect some of that inflationary change.

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  3. Inflation is an increasing money supply. As a result, prices goes up. Economists like to look at the CPI or PPI to measure what they call inflation. However, if the CPI number is calculated to be 2%, does that mean that everything is under control? Not necessarily. Firstly, the CPI can easily be calculated to be pretty much whatever you want it to be. Take one item you don’t like out of the basket and switch it with something you like, and suddenly you get a different number. Secondly, what about the portion of the money/currency creation that is currently held by foreigners, invested in the stock/bond market, or real estate? Are rising stock prices not a result of an increase in the currency supply and hence inflation?

    I wrote a short article about this topic recently. Feel free to take a look. It might provide a different perspective.

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    1. Completely agree. The government often tweaks wha5v8s in the CPI and PPI formulas. Likely the tweaks have a bias in them to make the,selves look good.

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      1. All statistics can be manipulated to show pretty much what you want it to be. The more complicated it is (or appear to be) the easier it is to fix it to mach your desired outcome. The prices are probably rising much faster than the official statistics. Btw, have you noticed or heard about shrinkflation?

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