Jim Solloway, Chief Market Strategist and Senior Portfolio Manager in SEI’s Portfolio Strategies Group, answers questions from Heather Corkery, Managing Director of Client Portfolio Management, in a two-part video series on the economic and investment outlook.

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Transcript

Heather: Hi, I’m Heather Corkery, Managing Director of Client Portfolio Management at SEI. Today, we’ll be discussing the economic outlook with Chief Market Strategist and Senior Portfolio Manager Jim Solloway.

Jim, thanks for taking the time to talk. I’d like to start by getting your thoughts on what seemed like a bit of a retrenchment that we saw this summer—certainly not a return to full-fledged lockdowns by any stretch, but a pause or at least a slowdown in the return to normal. How long do you expect this dynamic to last?

Jim: We suspect the gloom is already a bit overdone. The delta wave is in decline, which will help revive consumer’s spirits. Household wealth is at an all-time high owing to booming stock and home prices.

Heather: It’s certainly good news that rising asset prices have been bolstering household wealth. I wonder, though, if price pressures are a cause for concern, not necessarily in stocks and real estate, but more in general inflationary terms.

Jim: That’s entirely possible. We expect inflation to run at a higher rate for a longer period than has been commonly assumed, not just over the next one or two years, but well into the decade. 

Heather: The Fed’s economic projections show inflation returning back to 2% or so within a couple years. What are you seeing that raises concern about the prospect of persistent higher inflation?

Jim: We think the labor market is telling us an important story right now.

Jim: In the chart, we show the three-year trend in unit labor costs and the core Personal Consumption Expenditures Price Index. Changes in unit labor costs reflect changes in total labor compensation minus productivity, or output per hour. Plotting this against core PCE prices gives us a sense of how expensive workers have grown relative to inflation.

Growth in unit labor costs typically nosedives as the economy emerges from recession because compensation is low and productivity picks up sharply.

Something different is happening this time. Hourly compensation growth is already close to its previous cycle highs looking back over the past three decades. Labor productivity is also rising, but not nearly as fast as compensation.

As a result, unit labor costs have risen at a 2.7% annualized rate over the past three years, the fastest pace since the peak of the 2002-to-2007 expansion.

Jim: We don’t know if the labor shortage will ease enough to quickly reduce the pressure on compensation growth. Since US demand will probably stay robust as economic growth normalizes, it wouldn’t be surprising to see companies continue passing along their increased costs. Inflation over the long haul could be closer to 3% than the 2% or so currently expected by the Fed and most investors.

If that turns out to be the case, the current yield structure in the bond market may also prove to be unsustainably low, and the Fed may be forced to raise interest rates higher and faster over the next three years than anticipated. Inflation impacts how assets are priced.

Heather: Do you see a similar inflation overshoot outside the U.S.?

Jim: Other developed countries are broadly on the same path as the U.S., and reacting to the same catalysts. The challenges posed by COVID-19 and disruptions to production have pushed inflation in various countries to levels not seen in many years.

Jim: The U.K. has tended to be more inflation-prone over the past decade than the rest of Europe and even the U.S.

On a year-over-year basis, consumer prices surged almost 6% in the U.S. versus 4.7% for Germany, 3.0% in the U.K. and 3.6% in the EU. More than a percentage point of the difference between the U.S. and other regions comes from the soaring price of used cars and trucks. Some industries in the U.S.—primarily within services (that’s hotels, apparel, airfare, restaurants and catering)—are seeing prices rise faster compared to other parts of the world. 


Jim: This reflects an earlier reopening in the U.S. economy compared to Europe. Inflation in the U.S. may be near a peak, but a further acceleration appears to be in store for Europe. The immediate concern for households in the region is the cost of energy.

Heather: Thanks Jim. We always appreciate your insights.

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