Market volatility has spiked recently, driven largely by growing concerns about rising inflation and interest rates. We think the volatility is exaggerated, but we’re not surprised inflation is rising—and rates along with it.

One of the great mysteries of the current expansion is that even with strong economic performance, inflation has been very slow to respond. Many have even questioned the Phillips curve, a fundamental construct of macroeconomics and central banking: when an economy is strong, it will over time generate inflationary pressures. (We believe that structural factors are at play, too.)

The solid-growth, low-inflation mix has allowed the Fed to keep monetary policy very accommodative and to raise rates only gradually the last few quarters, even as unemployment has fallen to near-record lows. That environment has underpinned very strong financial market performance, so it’s little wonder that so many investors are focused so intently on inflation today.

Evidence of Higher Inflation Is Mounting

We do expect inflation to rise this year, and interest rates along with it. In fact, higher inflation has been a key driver of our 2018 forecast for some time.

And we’re seeing increasing signs of rising price pressure. Over the last six months, prices are up at a pace (Display) that, if maintained, would translate to a 2.5% increase in the consumer price index (CPI) over 12 months. January’s data showed an even faster increase—core CPI rose by 0.35% month over month, the fastest in more than a decade.