Stewart D. Taylor,  Diversified Fixed Income Portfolio Manager at Eaton Vance , a leading global fund manager says: “Perhaps the mystery isn’t that inflation is so low in the US, but that it has managed to stay so high in the face of so many deflationary trends.

“However, rather than lamenting a low and steady inflation rate and trying to push it higher, my view is they should instead be celebrating it. I believe that inflation, even modest inflation, is almost always a bad thing. Rising prices are an unseen tax that continually erodes the purchasing power of savings, and reduces the real return of investments,” he adds.

“Indeed, I find it somewhat disturbing that the Fed, most economists and the national press, without empirical evidence to support the contention, think otherwise. Take the July CPI report, which showed that price rose 1.7% from a year earlier. It bothers me that this lower-than-expected inflation report was universally described as “disappointing.”

I believe there is such a thing as “good deflation” that can benefit consumers and the economy. Here’s the difference between good and bad deflation:

• Good deflation occurs when gains in productivity or increased competition lead to lower prices. The resultant increases in purchasing power and savings are beneficial to consumers, particularly those in lower income cohorts with less discretionary income. Lower prices due to technology and innovation also fall into this category. Globalization also falls mostly into the good deflation category. It’s often overlooked, but the deflationary forces created by retailers that can tap economies of scale and online sales have been, on balance, beneficial to the purchasing power and the quality of life of U.S. citizens.
• Bad deflation is caused by an aggregate decline in demand. Due to its nature, it tends to be rapid as consumers and business become fearful of the future and decide to forgo purchases today in the expectation that they can be purchased cheaper later. This is the destructive deflation that the Fed should be concerned with.

Over the last 30 years, there has been a great deal of good deflation. Technological innovation has made us more productive, scientific management of agriculture and genetically modified organisms (GMOs) have reduced the unit cost of food, and shale oil technology and globalization have reduced the cost of a myriad of consumables. Additionally, the demographics of an aging developed world population and the change in the attitude toward consumption by the millennial cohort have all contributed.

“In my view, that inflation has managed to remain so high despite these detrimental macro forces is further evidence that inflation has become firmly embedded in our economy. Let’s not forget that, rightly or wrongly, the Fed is at war with all deflation and it has the tools to win both the battle and the war.

So there’s an old saying in markets: Don’t fight the Fed. To me, it would be foolish to assume that the central bank won’t ultimately win and produce higher inflation. I continue to think that short-duration inflation protection and real return assets are one of the few cheap assets classes and that inflation, after softening a bit over the next few months, will begin to surprise to the upside early next year”, he notes.

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