Over the past two years, the pandemic has been a big economic story driving both monetary and fiscal policy. Now a new concern is grabbing headlines: inflation.
Just as the development of vaccines opened the opportunity for meaningful re-engagement, the economy hit a couple of snags. The first was supply chain issues, which have resulted in supply not being able to keep up with the demand recovery. Then came what has been termed the great resignation or the seemingly permanent exit from the workforce resulting in labor shortages. Both the supply chain issues, and the labor shortages are contributing to the highest rate of U.S. inflation in four decades.
As the Federal Reserve seeks to put the right policies in place to combat the economic challenges, SWIB is also keeping a close eye on what it all means when it comes to the Wisconsin Retirement System with some great perspective from an inside expert.
To help navigate the situation, the State of Wisconsin Investment Board’s Leo Kropywiansky, a senior portfolio manager with the Asset & Risk Allocation Division, is drawing on his more than 25 years of experience as an economist, collaborating with staff insights, and using inflation modeling scenarios.
Furthermore, Kropywiansky draws on the expert perspective of SWIB Executive Director/Chief Investment Officer Edwin Denson, also an economist by training.
“Inflation has surprised on the upside in the last several months, and the timing of disinflation has been delayed,” said Kropywiansky, who holds a Ph.D. in economics from Massachusetts Institute of Technology. “One important thing we are watching is wage growth and the potential for a wage-price spiral.”
Looking ahead, the most plausible path for inflation is downward over the next two years, he said. Tighter financial conditions, including Federal Reserve interest rate hikes and weaker risky asset prices, will most likely take some steam out of the economy in 2022. In addition, waning consumer savings from pandemic fiscal relief, school re-openings, and easing fears of COVID infection in the workplace make a continued rise in labor supply likely, helping to moderate wage inflation.
Wage growth picked up markedly in the second half of 2021. This, as much as the goods and services inflation surprise, warrants a pretty fast pace of tightening by the Federal Reserve in 2022, with a plausible 0.25 percentage point rate hike at every remaining meeting.
“Right now, it looks like there is nowhere to hide when it comes to finding positive investment returns,” Kropywiansky said, adding, “The only good news is that these scenarios don’t last forever.”
The other good news is that SWIB’s asset allocation is fully diversified. “Some investments, such as the TIPS (treasury inflation-protected securities) portfolio are doing better than other assets,” Kropywiansky said, adding that the Core Trust Fund’s asset allocation target for TIPS is 19%.
“TIPS, which are a good way to project against inflation, have held up well and year-to-date are the best performing asset class,” he said. “What happens to the SWIB policy portfolio when the economy experiences surprising high inflation, and the Fed becomes more active? You typically see poor returns for risky assets like stocks and high yield bonds,” he added. “It can take some time for risky assets to find their footing again.”
In the meantime, Kropywiansky and the SWIB team will continue to use their expertise to help weather these turbulent times.