US inflation rates have been steadily rising





Inflation has been stubbornly low in the developed world, since the financial crisis in 2008. No amount of monetary stimulus has led to an increase in inflation rates, especially so in Europe and Japan.





However, in the last few years, the US has seen a steady increase in CPI (Consumer Price Index) inflation. As the first graph shows, the year-over-year change in inflation has steadily increased from around 0% to 2.3% as of December 2019.









The current inflation level in the US is just about where the Federal Reserve would like it to be. However, there are some factors that could push US inflation higher in 2020.





These factors could cause inflation to increase





US consumer spending remained strong throughout 2019, despite several headwinds, which could have potentially affected consumer sentiment.









Consumer spending has been driven by consistent positive real wage growth in the last six to seven years. We have also been seeing strong housing gains as a result of wage growth.

The job market has remained tight over the years, partly as a result of the Fed's loose monetary policy.





Could oil prices rise from here





Meanwhile, oil prices have been contained in the last decade, due to the excess supply. Lower oil prices have also helped keep inflation rates in check.





Any escalation in the tensions in the Middle-East could lead to oil prices going out of hand, though. This could have a cascading impact on inflation rates. To be sure, a lack of geopolitical tensions could keep oil prices at bay.





If inflation rates overshoot by a bit, the Fed might not be in a hurry to increase interest rates as economic growth remains fragile.





Moreover, equity markets have become more sensitive to monetary policy in recent years, which the Fed is cognizant of. Loose monetary policy was arguably one of the biggest drivers of the bull market in the previous decade.





What can you do if inflation rises





A little inflation is good for equities, especially demand-pull inflation. Equities have had a mixed history with inflation. The worst-case scenario for stocks is high inflation coupled with weak earnings growth.





In such scenarios, companies that are able to pass on the higher costs to customers tend to do outperform. These may include companies belonging to sectors like energy and industrials.





Meanwhile increasing inflation rates cause bonds, especially those with longer durations, to underperform. Treasury yields which are quite low could back up if inflation increases.





High-yield bonds tend to do better than Treasury and investment-grade bonds when inflation rises. However, if inflation is coupled with weak earnings growth, which might be the case, it would be better to eschew high-yield bonds.





The asset class which performs the best when inflation rises is gold. Gold prices are considered a good hedge against inflation, and especially is real interest rates are falling or low , which is the case.





Other commodities should also be considered. After all, an increase in commodity prices contribute to rising inflation.





Also, commodity-exporting economies like Brazil, Russia, and Latin American would improve. You could have exposure to these economies through ETFs like EWZ and FLLA.





However, oil and commodity importing emerging economies like India and Indonesia could underperform if commodity prices increase.





Inflation-protected Treasury bonds or TIPS is another option for investors seeking protection from inflation. Real estate also tends to go hand-in-hand with inflation. That said, REITs are slightly expensive at the moment.