Investment Insights
Inflation Checkpoint
Meghan Shue
Investment Strategist
Highlights
•• The December U.S. Consumer Price
Index (CPI) increased 2.1% year over
year, with many of the underlying
trends from recent months remaining
in place. Core prices (excluding food
and energy) rose 2.2%. Bessemer’s
index increased 2.3% year over year,
the highest rate since June 2014.
•• Policy changes under a Trump
administration are likely to continue
to have important consequences on
expected and realized inflation.
•• Lower tax rates will likely lift
Bessemer’s overall inflation index
through increased demand,
while tariffs could have a greater
inflationary impact on the prices of
specific goods, including automobiles,
technology, and apparel.
Exhibit 1: Inflation Expectations, Yields, and the
Dollar Post-Election
Key Takeaway: Trump’s election was followed by a sharp increase in
inflation expectations, interest rates, and the U.S. dollar.
a. University of Michigan Expectations (Next 12 Months)
%
3.1
3.0
2.9
2.8
2.7
2.6
2.5
2.4
2.3
2.2
2.1
Jan-15
Jul-15
One of the most dramatic market rotations since the
U.S. presidential election was the increase in inflation
expectations. The University of Michigan’s survey of
inflation expectations climbed to 2.6% in January
(Exhibit 1a), with some market-based measures of
inflation expectations increasing even more. This has
coincided with a sharp rise in Treasury bond yields
and a stronger U.S. dollar (Exhibit 1b).
January 19, 2017
Jul-16
Jan-17
b. Treasury Yield and U.S. Dollar
%
2.8
Index Level
128
2.6
126
2.4
124
2.2
122
2.0
120
1.8
1.6
118
1.4
116
1.2
Jan-16
May-16
10-Year Treasury Yield (L)
The Trump Effect
Jan-16
Sep-16
Jan-17
114
U.S. Dollar Index (R)
As of January 18, 2017.
Source: Bloomberg, J.P. Morgan, University of Michigan
Consumer expectations of higher inflation do not
necessarily mean realized inflation will follow, but
expectations are an important part of the function. Why
the sudden shift in expectations, and what does it mean
for the inflation felt by our clients? While no one (with the
exception of deflation-fearing central bankers) is usually
Bessemer Trust Investment Insights
Inflation Checkpoint
pleased to see prices rise for the goods and services they
purchase, we believe the source of the inflation is important
in determining whether it is “bad” or “good” inflation.
Exogenous Shocks
One source of “bad inflation” is an exogenous shock
that is not caused or accompanied by improving
growth. Examples would be the tariffs proposed by
President-elect Trump during his campaign and
the border-adjusted tax system proposed by House
Republicans, the latter taxing imports but not exports.
All else equal (excluding currency or other knock-on
effects), tariffs would lead to higher prices for many
goods without a commensurate increase in wages,
thereby lowering consumers’ real purchasing power.
The two countries receiving the bulk of Trump’s attention
are China and Mexico, which account for 16% and 14% of
U.S. total trade, respectively. Goods imported from these
countries tend to be concentrated in the technology, retail,
and automobile industries (Exhibit 2). Companies can
either eat the cost of higher tariffs through lower margins
or pass them on to consumers through higher prices;
in our view, a combination of these would be most likely.
Tariffs would likely result in a one-time price increase,
and while a portion of the effect could be offset by U.S.
companies substituting some of the goods facing import
tariffs with similar or similarly priced goods produced
by another trade partner, tariffs would still likely have
a damaging effect on consumer purchasing power.
Growth-Driven Inflation
In our view, some potential inflation related to policies
of the Trump administration could come from economic
growth and an increase in after-tax income. One of the
priorities of the new administration is tax reform, both
for individuals and corporations. While there are still
more questions than answers regarding what tax reform
could look like, we do believe it could include a reduction
in individual tax rates for all income brackets. The Tax
Policy Center analyzed the House Republicans’ tax
reform “blueprint” and determined that it would result in
an average increase in after-tax income in the first year
of 2.5% for all tax brackets. The top 20% would receive a
4.6% increase, so we would expect tax cuts and increased
demand to lead to higher inflation for Bessemer’s index.
Exhibit 2: U.S. Imports from China and Mexico, by End-Use Category (as % Total Imports from Each Country)
Industrial
Machines
Medicinal
Equipment
Household
Appliances
Vegetables
& Fruits
Crude Oil
Electric
Apparatus
Telecommunications
Equipment
Computers
Vehicles
& Parts
0
Electric
Apparatus
0
Footware
10
Household
Appliances
4
Vehicle Parts
& Accessories
20
Furniture
8
Telecommunications
Equipment
30
Toys & Games
12
Apparel, Textiles
%
40
Cell Phones &
Household Goods
U.S. Imports from Mexico
Computers &
Accessories
U.S. Imports from China
%
16
Televisions & Video
Equipment
Key Takeaway: Technology, automobile, and retail companies would be most affected by tariffs on imported goods from China or Mexico.
As of November 30, 2016.
Source: U.S. Census Bureau
2
Bessemer Trust Investment Insights
Inflation Checkpoint
Looking Ahead
Exhibit 3: Bessemer’s Inflation Index
In the short term, we expect current inflation
trends to persist and gradually lift overall prices.
Rising rental, oil, and fuel prices tend to increase
Bessemer’s index (Exhibit 3) but less than the CPI.
Longer term, should Trump proceed with tariffs
or a border-adjusted tax system, we would expect
higher automobile and apparel prices to modestly
increase Bessemer’s index relative to the CPI,
while higher prices for computers and technology
would have a greater inflationary impact on the
CPI at the margin. At Bessemer we understand
the importance of real, inflation-adjusted
purchasing power and portfolio returns, and
we will be monitoring policy shifts carefully
to adjust portfolios and our investment-planning
strategies accordingly.
Key Takeaway: The new administration’s policies could cause
Bessemer’s inflation index to increase slightly over the medium term.
% Chg, YoY
3.0
2.5
2.0
1.5
1.0
0.5
0.0
Jan-14
Jul-14
Jan-15
Jul-15
Jan-16
Jul-16
As of December 31, 2016.
Source: Bessemer Trust, Bureau of Labor Statistics
This material is for your general information. It does not take into account the particular investment objectives, financial situation, nor needs of individual clients. This material
is based upon information obtained from various sources that Bessemer Trust believes to be reliable, but Bessemer makes no representation or warranty with respect to the
accuracy or completeness of such information. Views expressed herein are current only as of the date indicated, and are subject to change without notice. Forecasts may not
be realized due to a variety of factors, including changes in economic growth, corporate profitability, geopolitical conditions, and inflation. Bessemer Trust or its clients may
have investments in the securities discussed herein, and this material does not constitute an investment recommendation by Bessemer Trust or an offering of such securities,
and our view of these holdings may change at any time based on stock price movements, new research conclusions, or changes in risk preference.
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