HedgeTalk: Inflationary Pressures – Are They Real?
By: Johan Rosenberg, Chairman
Today’s popular economic narrative says to expect a strong recovery with rising inflation at the same time. However, if we go into a recovery and inflation takes off, it is likely we would have a truncated recovery. With a weaker dollar comes a bigger trade deficit, and then inflation would push up interest rates, which will work against the recovery. And since prices generally rise faster than wages, real income would decrease. So, if we have a major acceleration in inflation, it also means an expansion would not hold. Therein lies the tension that has been created by today’s set of economic circumstances. Due to the exorbitant amount of pandemic stimulus funds coupled with a jaw-dropping proposed infrastructure bill, many believe money supply has increased too much. But money supply is less important than the speed with which it circulates, or “velocity,” which is at the lowest level ever. As long as excess debt is pushing velocity lower, aggregate demand will keep falling. Sustained, broad inflation under these conditions is impossible. During the last two months, we have all experienced anecdotal inflation: at the gas pump, purchasing a new computer (semi-conductors), in food prices, and buying a house (new home inventory has never been lower, and lumber prices are way up). Amazon bought up all the steel in the “whole country” for their Whole Foods expansion, and job openings are going unfilled. The idea is that rising prices – commodity and labor – will drive inflation. But historically, you may be surprised to learn that commodities have no correlation with inflation. Aside from restaurants and hotels, many workers remain at home. Endowed with hefty, work-disincentivizing stimulus checks through September, workers will probably wait and work thereafter. These effects should limit wage pressure, and that does not count the many ways businesses have become much more efficient and automated during the pandemic. The anecdotal evidence may not be real inflation; instead, it could be tremendous distortions and disturbances caused by the lingering effects of the pandemic. Everybody knows that after a big fast we tend to overeat, so maybe that is why we see sky-high car rental prices and surging airline travel, and with the price of oil embedded in all raw foods due to transport costs, the grocery store credit card charge is that much higher. What may be going on, in the supply side of the equation, is that businesses panicked and stopped buying. Inventories have decreased, and now they’re scrambling to catch up to meet surging demand, ordering two to three times more than usual, which will set up for a massive inventory glut in the fall. That sets the stage for deflation in the near–term future, perhaps even next year, or at the very least not scary inflation. Let’s muse over these concerns for a moment. After this supply chain–influenced bounce in inflation, many of the companies in the S&P 500 may be disintermediated or disrupted by technologically-enabled innovation such as DNA sequencing, robotics, energy storage, artificial intelligence, and blockchain technology. Who needs Uber, DoorDash, and semi-truck drivers when swarms of autonomous drone fleets deliver everything our hearts’ desire in less than an hour. Perhaps the cooking robot makes a better, more consistent Big Mac with fries and the robo-butcher cuts up a perfect pork chop 24/7, laying off millions working in the meat processing plants. And maybe healthcare costs are about to plummet in a few years as your entire genome will be sequenced for preventive care action at every doctor’s visit, using a $10 nasal swab. So, is the inflation concern real? “When” is probably the better question to ask. Consider these answers.
In the near term (until about Q3-Q4 2021), as we are already seeing, there could be significant inflationary pressures. In fact, recently released CPI measures for May exceeded forecasts, up 0.6% - this after a 0.8% posting in April, which was the largest increase since 2009.
In the medium term (2022-2023), if the economy falters after stimulus fades, inflation could move lower.
In the long run (after 2022), monetary excess (about $19 trillion, plus maybe $6 trillion more) and the need to liquidate debt by inflating out of it could send inflation sharply higher, possibly to the point of hyperinflation. This is unlikely, perhaps, at least from a historical U.S. market perspective, but it’s tough to grasp paradigms that no currently living 25- to 65-year-old administrator in the U.S. has ever dealt with.
Lastly, there seems to be little to no inflationary pressure elsewhere across the globe, and, in China, the economy is slowing down.
So, what to do?
Rates remain quite low, and muni market ratios are super low, so consider locking-in rates now, potentially with an upcoming or forward issuance, pending other considerations and breakeven analysis.
If you miss the window to lock-in a fixed rate or forward hedge, don’t fret - there are cycles and stimulus unwind, and economic growth stagnation could produce less inflation in the medium term.
In the meantime, perform 5- to 10-year proforma analyses to see what your institution’s revenues and expenses look like with both lower and higher inflation assumptions versus a standard 3.00% escalator, for example, and prepare your leadership to deal with an environment not seen in a couple of generations.
Note from Author:
Thank you to Mauldin Economics this article reflects my take-aways from the 2021 Strategic Investment Conference. Great presentations by John Mauldin, Lacy Hunt, David Rosenberg, Katherine Wood, Louis Gave, and Danielle DiMartino Booth.
If you would like assistance evaluating your position heading into uncertain times, please contact us:
Contact the Author: