Global Perspectives

A weekly analysis of timely economic strategy issues from Wells Fargo Investment Institute.

January 7, 2020

Gary Schlossberg, Global Market Strategist

Inflation—the Economy’s “Dog that Didn’t Bark”

Key Takeaways

  • We believe that deep-seated structural changes are as responsible for stubbornly low U.S. and global inflation as moderate growth and other short-term, cyclical forces.
  • We also believe that structural and cyclical headwinds to inflation are slowly eroding enough to support inflation’s modest rise, bringing an end to decades-long “disinflation.”1

What It May Mean for Investors

  • Even modestly higher inflation or gradual interest-rate increases (should rate increases unexpectedly occur) risk creating headwinds to a seemingly ageless U.S. economic growth cycle and an historic financial-asset rally. We believe that these positive developments stem partly from historically low interest rates and their effect on the economy’s interest sensitivity and asset valuations.

Download the report (PDF)

We believe inflation’s refusal to obey conventional economic wisdom by moving higher in a maturing growth cycle has been among the great economic mysteries over the past decade—as it has remained stuck below central-bank targets in the U.S. and abroad—despite policy makers’ generous cash injections into financial markets. The biggest surprise to us has been in the U.S., where an unemployment rate at a 50-year low has not been enough to move wage or price inflation back to precrisis levels. Stubbornly low inflation has been of more than passing interest to investors as many have benefited from the price lift to stocks, bonds, and other assets that resulted from historically low interest rates by central bankers who were determined to re-inflate their local economies.

More structural than cyclical

What gives? We believe that cyclical, or short-term, developments are partly to blame. The same moderate growth behind this expansion’s record longevity has lessened the threat of bottlenecks normally exposing the economy to price pressures during the expansion’s middle and late stages. Dollar strength—combined with economic sluggishness in Europe, Japan, and (more recently) China—has kept a lid on domestic prices abroad and on U.S. import costs tied to driving trade-sensitive “goods” prices in the Consumer Price Index (CPI).

Chart 1. A slow return by wage inflation to its precrisis level—despite a tight labor marketA slow return by wage inflation to its precrisis level—despite a tight labor marketSources: U.S. Department of Labor, Bureau of Labor Statistics, Federal Reserve Bank of Atlanta, December 30, 2019. * Median percent change in the hourly wage of individuals over the past 12 months.

But we believe there’s more to the extended bout of “disinflation” (a declining inflation pace) than the short-term, more temporary changes tied to the business cycle. For starters, inflation has been in secular decline since peaking (at a level above 14.5% in the U.S.) in the early 1980s—reflecting the tailwind created by structural, or more enduring, forces. In the U.S., Federal Reserve (Fed) Chairman Paul Volcker’s determination to break the back of inflation with extraordinary monetary tightening—and the deep recession that followed it—was a key catalyst for inflation’s extended declines here and abroad (through the dollar’s central role as a transaction currency in world trade and finance and its effect on global inflation and interest rates).

Beyond that is a laundry list of profound economic changes that coincided with (and resulted partly from) the shock to inflation more than 35 years ago. Several helped to reverse so-called “institutional rigidities” that contributed to the “great inflation” of the mid-1960s, 1970s, and early 1980s. Among the most visible was “globalization” in a more fully integrated world economy—led, eventually, by China—exposing established players to an array of low-cost producers. Equally visible was the push toward deregulation, paced by the economies of the U.S., U.K., Canada, and elsewhere, combined with the growing importance of less capital-intensive technology and services industries adding to competition by lowering entry barriers for new and innovative firms.

The growth and concentration of social media firms (and certain other technology firms) created an unexpected and added inflation headwind through a different model that relied more on hidden and less apparent costs in an effort to create value. Technological change extended to online shopping (via the so-called “Amazon effect”) and resulted in undercut prices of products offered by established, brick-and-mortar retailers. Feedback from the subdued inflation’s effect on business pricing power reinforced the trend. Companies’ efforts to maintain profit margins in a weak pricing environment encouraged sales of less costly, private-label goods and partly undercut wage growth as businesses sought to manage labor costs.

The more cautious spending patterns of a growing retiree cohort in an aging U.S. population also contributed to price restraint. At the other end of the spectrum, mounting student loan debt and lifestyle changes have tempered U.S. housing demand, and with it, housing-related expenditures that are a sizable share of the CPI. Measurement issues affecting the CPI also have weighed on U.S. inflation, most notably quality adjustments to standard consumer goods like computers, smartphones, and other “high tech” equipment that lowered the measured price of these goods in the CPI.

Chart 2. Outsized U.S. inflation rates have been more the exception than the rule (Rolling five-year average annual percent change in the CPI)Outsized U.S. inflation rates have been more the exception than the rule (Rolling five-year average annual percent change in the CPI)Source: U.S. Department of Labor, December 30, 2019.

When these forces are combined, the pressure still may be modest enough to keep inflation well within its long-term norm. In a more leveraged, interest-rate-sensitive economy, with increasingly elevated stock, bond, and other asset values, however, the increases could be viewed as a yellow flag, meriting some caution for those on Wall Street and Main Street.

1 Disinflation is a short-term slowing of the pace of price inflation.

Risk Considerations

Each asset class has its own risk and return characteristics. The level of risk associated with a particular investment or asset class generally correlates with the level of return the investment or asset class might achieve. Stock markets, especially foreign markets, are volatile. Stock values may fluctuate in response to general economic and market conditions, the prospects of individual companies, and industry sectors. Bonds are subject to market, interest rate, price, credit/default, liquidity, inflation and other risks. Prices tend to be inversely affected by changes in interest rates.


Consumer Price Index (CPI) produces monthly data on changes in the prices paid by urban consumers for a representative basket of goods and services. An index is unmanaged and not available for direct investment.

Global Investment Strategy (GIS) is a division of Wells Fargo Investment Institute, Inc. (WFII). WFII is a registered investment adviser and wholly owned subsidiary of Wells Fargo Bank, N.A., a bank affiliate of Wells Fargo & Company.

The information in this report was prepared by Global Investment Strategy. Opinions represent GIS’ opinion as of the date of this report and are for general information purposes only and are not intended to predict or guarantee the future performance of any individual security, market sector or the markets generally. GIS does not undertake to advise you of any change in its opinions or the information contained in this report. Wells Fargo & Company affiliates may issue reports or have opinions that are inconsistent with, and reach different conclusions from, this report.

The information contained herein constitutes general information and is not directed to, designed for, or individually tailored to, any particular investor or potential investor. This report is not intended to be a client-specific suitability analysis or recommendation, an offer to participate in any investment, or a recommendation to buy, hold or sell securities. Do not use this report as the sole basis for investment decisions. Do not select an asset class or investment product based on performance alone. Consider all relevant information, including your existing portfolio, investment objectives, risk tolerance, liquidity needs and investment time horizon.

Wells Fargo Advisors is registered with the U.S. Securities and Exchange Commission and the Financial Industry Regulatory Authority, but is not licensed or registered with any financial services regulatory authority outside of the U.S. Non-U.S. residents who maintain U.S.-based financial services account(s) with Wells Fargo Advisors may not be afforded certain protections conferred by legislation and regulations in their country of residence in respect of any investments, investment transactions or communications made with Wells Fargo Advisors.

Wells Fargo Advisors is a trade name used by Wells Fargo Clearing Services, LLC and Wells Fargo Advisors Financial Network, LLC, Members SIPC, separate registered broker-dealers and non-bank affiliates of Wells Fargo & Company.