Research report

What’s driving higher inflation and what to expect in 2022

Inflation looms as the biggest economic uncertainty for investors and policymakers. We build a bottom-up scenario and break down risks in 2022.

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December 10, 2021 | 17 minute read

As inflation accelerates to 6.8% year/year, the highest rate since 1982, the outlook for what’s next warrants a close look. We build a bottom-up scenario based on the various drivers of inflation on seven key categories. We expect inflation to ease to around 3% by the end of 2022, but the current elevated pace could remain through Q1 of next year. Markets may need to get comfortable with uncomfortably high inflation in 2022.

Key takeaways

  • CPI hit 6.8% y/y in November, the highest since 1982.
  • We develop a bottom-up scenario based on 7 broad categories in CPI.
  • Headline inflation could stay near multi-decade highs into Q1 2022.
  • We expect inflation to decelerate to 3% y/y by end-2022, enough to erode nominal returns and remain a challenge for traditional investments.

The consumer price index rose 0.8% in November, putting inflation at 6.8% year-over-year, the highest since 1982. Inflation’s acceleration this year has been disquieting – at the start of 2021, inflation was just 1.4% y/y. Core inflation – which excludes food and energy – rose 0.5% in the month and is now up 4.9% y/y, also a fresh 30-year high. In November, most categories continued to show inflation far above pre-pandemic trends. New and used vehicles posted 1.1% and 2.5% monthly gains (respectively), and used car & truck inflation is now at 31.4% y/y. On the services side, owners equivalent rent (OER), rose 0.4% for the third month in a row. Households are facing rising inflation bubbling up from almost every corner of the economy.

Consumer price inflation continues to surge

Source: Bureau of Economic Analysis, as of December 10, 2021. 

The outlook for inflation remains highly uncertain. Many factors have combined to drive inflation to multi-decade highs. Furthermore, inflation has proven more broad-based and entrenched than had been expected at the start of the pandemic, or even at the start of 2021. The double-digit inflation of the 1970s looms as a significant concern for many investors, even though it is not the consensus estimate or our expectation.

Given the confluence of factors driving inflation, we opt for a bottom-up approach for our inflation outlook for 2022. We discuss seven broad sectors of CPI, and what we expect in the coming year. Inflation could remain at multi-decade highs, or even accelerate somewhat in Q1 before renormalizing somewhat in the second half of 2022. By the end of next year, our expectation is that inflation will be around 3.0% y/y, still above pre-pandemic levels.

It does not take runaway inflation for rising prices to have a detrimental impact on traditional 60/40 portfolio returns, particularly given historically low interest rates. Even inflation of 3% could erode nominal investment returns and weigh on economic sentiment. Far from transitory, inflation will loom as a challenge for much of next year.

This information is educational in nature and does not constitute a financial promotion, investment advice or an inducement or incitement to participate in any product, offering or investment. FS Investments is not adopting, making a recommendation for or endorsing any investment strategy or particular security. All views, opinions and positions expressed herein are that of the author and do not necessarily reflect the views, opinions or positions of FS Investments. All opinions are subject to change without notice, and you should always obtain current information and perform due diligence before participating in any investment. FS Investments does not provide legal or tax advice and the information herein should not be considered legal or tax advice. Tax laws and regulations are complex and subject to change, which can materially impact any investment result. FS Investments cannot guarantee that the information herein is accurate, complete, or timely. FS Investments makes no warranties with regard to such information or results obtained by its use, and disclaims any liability arising out of your use of, or any tax position taken in reliance on, such information.

Any projections, forecasts and estimates contained herein are based upon certain assumptions that the author considers reasonable. Projections are necessarily speculative in nature, and it can be expected that some or all of the assumptions underlying the projections will not materialize or will vary significantly from actual results. The inclusion of projections herein should not be regarded as a representation or guarantee regarding the reliability, accuracy or completeness of the information contained herein, and neither FS Investments nor the author are under any obligation to update or keep current such information.

All investing is subject to risk, including the possible loss of the money you invest.

Lara Rhame

Chief U.S. Economist + Managing Director

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