2017 is the year inflation makes a comeback—and Donald Trump could play a role

This is the year inflation worries could begin to simmer for the first time in ages.

After years of worrying about deflation, the stock market could catch a whiff of inflation later in the year. In its 2017 outlook, Charles Schwab pulled inflation to its "front burner" list of concerns for stocks and pushed deflation to its "back burner." Others feel the same.

"In the second half of the year, we think there's going to be some headwinds in the market with people worrying about wage inflation in 2018, and the Fed being behind the curve. It's not necessarily that they're going to be realities, but I think at the end of the year, people are going to be worried about inflationary pressures, largely coming from wages," said Scott Wren, senior global equity strategist at Wells Fargo Investment Institute.

Steven Wieting, global chief strategist at Citi Private Bank, expects President-elect Donald Trump's plans for fiscal stimulus and tax cuts to boost GDP by more than a full percent this year. But those programs should also bring some inflation.

"While they may succeed in postponing the timing of the next cyclical downturn in the U.S. and world economy, this could come at a cost of a more severe downturn later on. One major risk of fiscal stimulus so late into an economic cycle is inflation," Wieting wrote in his 2017 outlook.

Just like anything, too much inflation would not be good. But the lack of it has been a concern, and after years of little price traction, strategists see it picking up to a still comfortable pace.

"I don't think inflation is going to be a crushing inflation," said Wieting in an interview. "But consumers in the United States don't get wage adjustments for inflation."

Service sector prices could be the biggest driver of inflation because that is the most labor intensive part of the economy, said Stephen Stanley, chief economist at Amherst Pierpont.

"I think we could see headline inflation by the end of this year running the high 2s and the core could be well over 2 percent as well," said Stanley. He expects wage growth of about 3 percent by the end of next year.

"If the Trump administration is able to successfully shepherd through a lot of things they are advocating that would be positive for growth. You could see a boost to growth without it being terribly inflationary ... I'm more hawkish on inflation than most. It's not because of the fiscal side, it's because I think the Fed has already fallen behind the curve," Stanley said.

That inflation target is even before considering potential effects from the still-unknown variables likely to be generated by Trump's planned trade policies. Wieting does not expect to see protectionist moves from the Trump administration but he said trade is the biggest risk to his forecast.

He and others expect the Fed to raise interest rates faster if inflation moves up too quickly. For now, it is still sluggish — under the 2 percent targeted by the U.S. central bank, for a fifth year now.

The Fed's preferred measure of inflation, the personal consumption expenditure price index, showed core inflation at just 1.6 percent in November. Less than half of Fed officials expect inflation to reach 1.9 to 2 percent this year, and the rest have a lower forecast.

But many economists have been forecasting that inflation could finally break above the Fed's 2 percent target in 2017. Jefferies economists say inflation is accelerating primarily because commodities prices are again rising and commodities-based goods prices are going higher. They expect consumer price index inflation to surpass the central bank's 2 percent target in the first quarter and approach 3 percent by the end of the year. They see PCE at about 2.5 percent at year-end.

Schwab strategists said the return of inflation could help to lift sales for global companies and boost business confidence and spending. A rising dollar could keep inflation in check, they said, and as long as it does not rise too much, stock valuations seem reasonable. They expect the Fed to raise rates twice this year as inflation picks up.

Michael Gapen, chief U.S. economist at Barclays, actually included in his inflation forecast what many economists have left as unknowns — the potential impact of tariffs on inflation. So far, it's unclear what Trump will do about taxing goods at the border, but the president-elect has said companies that go overseas to manufacture should pay an expensive tax on goods shipped back into the U.S.

On Thursday, Toyota was the latest company to be warned by Trump on Twitter to build cars in the U.S., not Mexico or pay a huge tax.

"In our outlook for this year, we did assume that the Trump administration applies tariffs to both Mexico and China.Some of our improvement in inflation, firming in inflation in our forecast for 2017 is a result of imposition of trade restricting policies. Even aside from that, there's good reason to expect inflation would continue to firm. It would come from different sources," said Gapen. He said he expects inflation this year to come domestically from increases in wages, services sector prices and higher shelter costs.

Congress has also separately suggested a border tax, which would act similar to a valued-added tax. The tax could be 15 to 20 percent depending on what level the corporate tax rate is cut to, from its current 35 percent.

The border-adjusted tax would tax all incoming goods and services, but not exports out of the U.S. It's unclear what will happen with the proposal, but congressional leaders have said it's an important part of the corporate tax overhaul.

Gapen estimates 2.4 percent for core PCE inflation by the fourth quarter of the year, and 2.3 percent on headline. Of that, 0.2 percent is due to his estimates of a 7 percent tariff on Mexican goods and a 15 percent tariff on Chinese imports. But if there is a border tax, he said the inflation hit could be much greater and difficult to forecast.

Gapen said the inflationary impact of the increase in oil prices should be greatest in the first quarter since crude bottomed last February.

Proponents of the border tax expect a rising dollar to offset the impact of higher costs of goods to consumers. But critics are doubtful the dollar would rise enough to offset it.

In the minutes of its last meeting released Wednesday, the Fed noted that it expects fiscal stimulus but the impact on the economy is unclear. However, many central bank officials said there could be an upside risk to their forecasts. But they also noted it could potentially be inflationary or cause the dollar to rise.

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