The Federal Reserve is focused on getting inflation down to its 2% target, even if that means further rate raises, as Federal Reserve Chair Jerome Powell made clear in his remarks at the Jackson Hole economic symposium last month. This means understanding where inflation is going is key to determining the outlook for interest rates and, ultimately, the U.S. economy.

We recently sat down with Paula Horn, Chief Investment Officer (CIO) for Brookfield’s Public Securities Group (PSG), to discuss what inflation signals she’s watching as she helps PSG’s investment teams navigate their real asset strategies in today’s uncertain economic environment. She shared three inflation signals she’s watching closely and their implications for listed real assets.

China. Paula believes Chinese growth in 2023 will more than likely fall short of the Chinese government’s “unimpressive” 5% target, as she says China’s policymakers appear more focused on debt management than supporting the property sector and stimulating consumption. As a result, China “is a large global disinflationary force” for the global economy, Paula says.

Energy. Falling prices for oil and gas earlier this year were one reason for the recent drop in the U.S. headline Consumer Price Index (CPI) inflation rate. However, that trend is unlikely to continue, with energy poised to be a reflationary force in coming months, according to Paula. The price of oil, as measured by West Texas Intermediate crude oil, has risen about 23% this quarter through the end of August.  

The Performance of Cyclicals vs. Defensives. According to Paula, the outperformance this year of cyclical stocks over defensive counterparts appears to reflect the market’s view that a reflationary impulse from fiscal stimulus is still working through the system. Public and private spending supporting onshoring, the CHIPS Act and the Inflation Reduction Act have had a procyclical inflation impulse, very atypical during a Fed tightening cycle, boosting growth even in the face of rising interest rates. However, she notes that utilities equities have been outperforming very recently. She believes this trend bears watching. She says it could signal that the market senses an end to growth impulses and an economic slowdown ahead, given the lagged impact of one of the most aggressive rate hiking campaigns on record.

Based on these mixed signals, Paula says it’s not clear that the Fed’s job is done on the inflation front. The more that central banks raise rates, the less chance there is of a soft landing, in her view. Given the persistent macroeconomic uncertainty, Paula says PSG’s investing teams remain focused on playing defense by investing in companies with quality earnings, good balance sheets and solid cash flows. She says the real estate equities team is finding such companies in the health care, industrial and residential sectors, while the infrastructure and real asset debt teams see opportunities in towers, utilities and select energy infrastructure firms.

Energy infrastructure was a very strong performer in the first half of the year, despite falling energy prices. Historically, the performance of energy infrastructure equities has correlated with that of the underlying commodities, such as oil, but that relationship does not appear to be as tight as in prior cycles. Paula attributes this to the companies’ strong emphasis in recent years on capital discipline and returning capital to shareholders in the form of dividends and buybacks, trends our investment teams see continuing regardless of what happens with energy prices.