Join Fund Library now and get free access to personalized features to help you manage your investments.
To appreciate the strength of economic recovery from the sharp 2020 Covid-19 recession, look no further than the labor markets. Unemployment rates around the world have fallen toward pre-pandemic lows. In most developed markets, pretty much anyone who wants a job can find one.
Fewer workers are participating in the labor force than before the pandemic, and the higher wages they can secure as employers compete for them threaten to take already accelerating inflation to a new, more worrisome level. Wage inflation is “sticky.” Although it takes time for wages to climb in tandem with broader prices, when they do, they’re fully along for the ride and ready to jump into the driver’s seat.
Central banks have underestimated this strength in labor markets and the growing wage pressures. In my view, markets are underestimating the degree to which central banks will need to use their powerful tools to pull inflation back to acceptable levels.
Higher rates are in the U.S. economy’s best interest, a point I emphasized in a previous commentary. Vanguard believes that the Federal Reserve may need to raise its target for short-term interest rates to 3% from its current range of 0%-0.25%. That would require steady rate hikes over the next few years, to a degree that markets haven’t priced in beyond 2022.
(In a Q&A, Vanguard economists Josh Hirt, Asawari Sathe, and Adam Schickling discuss labor, inflation, our 3% figure, and the potential risks of the Fed moving too aggressively or not aggressively enough.)
Bond investors should welcome the prospect of higher interest rates. Although rising rates may produce modest negative returns for a time, they’re a long-term positive. We recently wrote about the dynamics of bond duration and rising rates – how investors with a longer horizon than their portfolio’s duration stand to benefit.1 Raising short-term rates should also forestall a rise in long-term bond yields because expectations of future inflation should not rise further.
Equity investors may feel less hopeful, and that’s understandable. In recent years they’ve come to enjoy some heady returns, fueled by negative after-inflation interest rates. The removal of such stimulus as central banks address inflation suggests turbulence ahead.
But negative real interest rates and the higher equity valuations they’ve promoted have come at a cost of future returns. That’s why our long-term outlook for equities, as we discuss in the Vanguard economic and market outlook for 2022, is so guarded.
The theme of our annual economic outlook, “Striking a better balance,” acknowledges the challenges that policymakers face in removing monetary and fiscal support that propped up economies during an unprecedented crisis. Surging inflation won’t come down magically. The path for central banks is clear.
Accelerating inflation is a threat to economies that otherwise remain fundamentally sound. Raising interest rates to subdue it should extend the growth cycle, not shorten it.
1. Duration is a measure of bond prices’ sensitivity to a change in interest rates.
Joseph H. Davis, PhD, is a Vanguard principal, global chief economist, and global head of The Vanguard Group, Inc.’s Investment Strategy Group, whose research and client-facing team develops asset allocation strategies and conducts research on the capital markets, the global economy, portfolio construction and related investment topics. As Vanguard’s global chief economist, Mr. Davis is also a key member of the senior portfolio management team for Vanguard Fixed Income Group.
Disclaimer
Content © 2022 by Vanguard Group. All rights reserved. Reproduction in whole or in part by any means without prior written permission is prohibited. This article first appeared on the “Insights“ page of the Vanguard Group, Inc.’s website. Used with permission.
Publication date: January 2022
The information contained in this material may be subject to change without notice and may not represent the views and/or opinions of Vanguard Investments Canada Inc.
The information contained in this material may be subject to change without notice and may not represent the views and/or opinions of Vanguard Investments Canada Inc.
Certain statements contained in this material may be considered "forward-looking information" which may be material, involve risks, uncertainties or other assumptions and there is no guarantee that actual results will not differ significantly from those expressed in or implied by these statements. Factors include, but are not limited to, general global financial market conditions, interest and foreign exchange rates, economic and political factors, competition, legal or regulatory changes and catastrophic events. Any predictions, projections, estimates or forecasts should be construed as general investment or market information and no representation is being made that any investor will, or is likely to, achieve returns similar to those mentioned herein.
While the information contained in this material has been compiled from proprietary and non-proprietary sources believed to be reliable, no representation or warranty, express or implied, is made by The Vanguard Group, Inc., its subsidiaries or affiliates, or any other person (collectively, "The Vanguard Group") as to its accuracy, completeness, timeliness or reliability. The Vanguard Group takes no responsibility for any errors and omissions contained herein and accepts no liability whatsoever for any loss arising from any use of, or reliance on, this material.
This material is not a recommendation, offer or solicitation to buy or sell any security, including any security of any investment fund or any other financial instrument. The information contained in this material is not investment advice and is not tailored to the needs or circumstances of any investor, nor does the information constitute business, financial, tax, legal, regulatory, accounting or any other advice.
The information contained in this material may not be specific to the context of the Canadian capital markets and may contain data and analysis specific to non-Canadian markets and products.
The information contained in this material is for informational purposes only and should not be used as the basis of any investment recommendation. Investors should consult a financial, tax and/or other professional advisor for information applicable to their specific situation.
In this material, references to "Vanguard" are provided for convenience only and may refer to, where applicable, only The Vanguard Group, Inc., and/or may include its subsidiaries or affiliates, including Vanguard Investments Canada Inc.
Commissions, management fees, and expenses all may be associated with investment funds. Investment objectives, risks, fees, expenses, and other important information are contained in the prospectus; please read it before investing. Investment funds are not guaranteed, their values change frequently, and past performance may not be repeated. Vanguard funds are managed by Vanguard Investments Canada Inc. and are available across Canada through registered dealers.
This material is for informational purposes only. This material is not intended to be relied upon as research, investment, or tax advice and is not an implied or express recommendation, offer or solicitation to buy or sell any security or to adopt any particular investment or portfolio strategy. Any views and opinions expressed do not take into account the particular investment objectives, needs, restrictions and circumstances of a specific investor and, thus, should not be used as the basis of any specific investment recommendation. Investors should consult a financial and/or tax advisor for financial and/or tax information applicable to their specific situation.
All investment funds, including those that seek to track an index are subject to risk, including the possible loss of principal. Diversification does not ensure a profit or protect against a loss in a declining market. While the Vanguard ETFs are designed to be as diversified as the original indices they seek to track and can provide greater diversification than an individual investor may achieve independently, any given ETF may not be a diversified investment.
All monetary figures are expressed in Canadian dollars unless otherwise noted.
Join Fund Library now and get free access to personalized features to help you manage your investments.
Fund Library
