Now Can We Expect Some Inflation?
If inflation is ultimately the result of too much money chasing too few goods and services, what are the prospects for an inflationary outcome in 2021? As the world’s leading economies slowed to a crawl in 2020 and global interest rates hover around zero, inflation might seem the least of our worries. On the other hand, major central banks and governments have thrown their fiscal and monetary spigots wide open.
Due to the pandemic, central bankers have signaled a continuation of the highly accommodative policy of low interest rates for the foreseeable future. In addition, global governments have announced nearly $12 trillion in stimulus measures according to the International Monetary Fund’s (IMF) latest annual report. As a result, financial assets may already reflect the first phase of an inflation effect – stock prices propped up by the promise of ample liquidity despite lower earnings and financial stress.
With global GDP expected to report a decrease of 4.9% for 2020 according to the IMF, the resulting large output gap and high unemployment have depressed headline inflation for now, allowing global central banks to keep feeding liquidity to the system. But shifts in a couple of key factors could help fan the inflation embers in the years ahead.
Many advanced economies are now seeing an aging demographic resulting in fewer workers relative to those their labors must support. As retirees step away from the labor pool, they continue to consume a wide range of goods and services. That impending supply challenge relative to underlying demand could be inherently inflationary.
Economists are also taking note of the rapid growth in money supply. In the wake of the global financial crisis of 2007, broad money supply growth collapsed, as shown in the following chart:
In contrast, today’s broad measures of money supply are posting strong growth. If that trend holds, the stimulus and liquidity pushed by governments and central bankers is likelier to help fill the sails of inflation.
The Federal Reserve is hoping to achieve a 2% inflation target and is willing to see that exceeded for a period to more rapidly fill the output gap mentioned above and reduce unemployment. And while financial markets appear to anticipate a robust recovery in demand and a relatively rapid restoration of jobs, businesses, and the trappings of “normal” life, financial assets have just recently started pricing in higher inflation and cyclical growth.
Other than gold, most familiar ways to position investment portfolio’s for increased cyclicality and inflation – commodities, industrials, materials stocks, etc. – lagged sectors such as technology and healthcare, not to mention the significant returns for high-grade, long-term bonds over the past number of years. But for everything there is a season.
Written By Lynn Snyder, CFA