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Is Inflation Back? Sorta Depends on Who's Asking About What

February 9, 2017
Is a 2017 market inflation imminent?

If you recently purchased a new home or paid for knee replacement surgery, it might seem like inflation has gone haywire. On the other hand, if you’re shopping for an airplane flight, groceries, or a TV set, you may find bargains galore.

There’s been a lot of talk lately about rising inflation, and the Federal Reserve has committed to several interest rate hikes this year as part of a strategy to help keep it at bay. But is inflation really a factor at all? Are we seeing it, and if so, where? And is the Fed right to be worried about inflation rising further as the year continues?

The consumer price index (CPI) is perhaps the best-known measure of inflation. In December, CPI rose 0.3%, while core CPI, which strips out volatile food and energy prices, rose 0.2%, the government said. On a year over year basis, total CPI is up 2.1% on an unadjusted basis, the largest 12-month increase since the period ending June 2014. Core CPI is up 2.2% over the same 12 months.

“Inflation rates are rising, but they remain relatively low,” said Patrick O’Hare, chief market analyst at “But of course, the trend is what’s catching the eye of the Federal Reserve and the market.” The Fed expects to raise interest rates three times this year, although CME Fed funds futures don’t project a 50% chance of a hike in any month before June.

Health and Housing: The Two Hs of Today’s Inflation

One thing to remember about inflation is that it’s often in the eye of the beholder. Some people are suffering more from inflation than others, and it depends on their current needs. Health care and housing costs are rising faster than overall inflation, affecting different demographics.

The average health insurance deductible rose 12% year over year in 2016 to $1,478, and has climbed 49% since 2011, according to the 2016 Kaiser/HRET Employer Health Benefits Survey. When workers choose higher-deductible plans to save upfront costs, it can mean paying more for medical care when they need it.

Higher health care costs tend to have an outsize impact on the elderly, O’Hare said. At the same time, elderly people who rely on savings and Social Security for much of their income have suffered from low interest rates for years, which means only small gains in their Social Security checks and little to no income from savings. So elderly people might be feeling more bite from inflation than some other age groups.

Another suffering group may be millennials, and that’s related to housing. U.S. house and home prices rose nearly 6% year over year to above their pre-recession peaks as of late last year, according to the S&P CoreLogic Case-Shiller U.S. National Home Price NSA Index, which covers some of the largest metropolitan areas. A strong jobs market, a tight housing supply, and low mortgage rates helped drive prices higher.

But even the strong jobs market has brought about only a 3% growth in wages, well below the nearly 6% rise in housing costs. That could particularly hurt young people starting out in the world and trying to buy their first home. For middle-aged and older people, who may already own homes and even have paid off their mortgages, the higher home prices seem like a nice reward. For a young person, they may seem more like a punishment, and could lead to cutting back on other expenses.

“If your disposable income is up only 2.3%, then anything that’s gone up more than that hurts,” O’Hare said. “You don’t have as much purchasing power, and you get into trade-offs. If you spend more on medical care or housing, maybe it means you have to eat out less or not take the vacation you want to take or cut back on driving.”

The 2.3% figure reflects the increase in real disposable income year over year through November (the most recent data available), according to the U.S. Department of Commerce.

Commodity Prices Also Advancing

Aside from housing and medical care, commodity inflation is also starting to perk up, which could drive higher consumer prices if it continues.

“It’s interesting to note that commodity prices (notably oil and metals, which are big raw material input) are increasing, even despite a relatively strong U.S. dollar,” said Devin Ekberg, content manager and writer for Investools®, TD Ameritrade’s education affiliate. “That tells me that demand activity is present, which is an absolute requirement for inflation expectations to become reality. The demand activity represents the classic ‘demand-pull inflation’ that would cause a rise in wages and asset prices.”

Still, Ekberg added, there’s a huge glut of commodities that might get bigger as prices go higher and more producers enter the market. “If anything derails the hope for future inflation, it would likely be commodities taking another turn downward,” Ekberg said.

Don’t Forget to Measure Stocks and Wage Inflation

Although CPI remains useful, not all inflation is included in that data point. For instance, if you own stock, you’ve seen inflation, but in a good way, as the S&P 500 Index (SPX) rose nearly 10% in 2016. Of course, that’s made stocks more expensive in general, so perhaps a bit less easy for newcomers to attain a foothold in the market. Pity again the poor millennials.

Wages are also up, although not by a huge amount, and that could be seen as helpful for workers—though perhaps not so good for companies that might take a hit to their bottom line as they pay their employees more money.

Prices for some items are actually falling or not keeping up with inflation, including groceries and some electronic items such as television sets. Airfares are also down, partly because many airlines are struggling with too much capacity.

Inflation and the Markets

Historically, when inflation rises to 4% or above, the stock market tends to weaken, said Sam Stovall, chief investment strategist for CFRA. Stock sectors that historically suffer the most when inflation rises include financials and real estate. But the energy and information technology sectors often rise during inflationary periods, CFRA research finds.

Rising inflation could hurt larger-cap companies because higher interest rates could boost the U.S. dollar, making U.S. products more expensive for overseas customers. Small-cap firms, which tend to export less, could be shielded better from inflation, Stovall said.

Stovall tends to be a bit skeptical that inflation can really make a big run this year, especially because he’s not sure that a Republican Congress is too eager to start spending on infrastructure when the country’s debt is at a high level of gross domestic product (GDP). He also expects relatively moderate economic growth in 2017, traditionally not an environment that tends to promote inflation. And he’s not convinced that energy prices, which have doubled over the last year, can keep up their pace.

“We’re expecting a change in core CPI from 2.2% now to 2.3% by the end of the year,” Stovall said. “That’s not a very big jump.”

O’Hare says some of the inflation concerns stem from the new administration’s proposed economic policies.

“You could see higher inflation from a stimulus … and if you see a border tax adjustment, that could potentially lead to trade wars and raise the cost of imported goods for U.S. companies that manufacture abroad but import to the U.S.,” O’Hare said. “That’s why there’s concern about higher inflation in 2017, based on some of the policies from Trump.”

Inflation and rising dollar index


U.S. dollar index futures, plotted here on the TD Ameritrade thinkorswim® platform, made a strong move in the last weeks of 2016 amid thoughts that the new administration might provide more stimulus to the economy. The Fed has forecast higher interest rates to fend off inflation, and that’s helping to buttress the dollar, a potential blow to multinational firms. Source: TD Ameritrade. For illustrative purposes only. Past performance does not guarantee future results.

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