The rapid growth of the U.S. money supply and the continued rise in commodity prices have raised concerns about a resurgence of Inflation. These concerns have been reflected in inflation-linked securities, and the 10-year U.S. equilibrium inflation rate rose from 0.5% in March last year to just under 2% at the end of last year.
We believe there are 3 scenarios that could bring inflation back.
The first is a technical one, where inflation is not accurately measured and the common indices underestimate it. Admittedly, it was difficult to calculate prices in the service sector during the Epidemic. Many businesses were not open, meaning that data could not be collected in the normal way. In fact, some of the price data was simply extrapolated, or even simply recorded as “unavailable”.
However, the measurement error is more due to a shift in consumption patterns during the epidemic. Consumption patterns have been forced to adjust, so that the use of CPI weights based on normal patterns does not reflect the changes in the economic environment affected by the epidemic. Inflation was skewed downward as almost all regions experienced higher Food prices and lower transportation prices during the epidemic.
While there is clearly a problem unique to the epidemic, this should fade as consumption patterns return to normal in 2021. The disruptions caused by the epidemic have left inflation slightly understated on a one-Time basis, but this should not last.
The second concern is the large increase in currency, implying excess liquidity. Once economic activity returns to normal, there is a risk of a consumption boom and strong demand will push up prices. While there seems to be hope for a return to normal Life and consumption, the chances of “post-traumatic stress” are not insignificant. It may take some time for families to regain confidence in spending. As more people choose to work from Home and travel less, there will be a permanent shift in some spending patterns.
Increased savings levels are occurring around the world, but mainly from the wealthier working population and retirees. Low-income earners typically slow or stop saving, and it is not surprising that those who are unemployed and out of work spend all their savings. While fiscal policy can mitigate this by implementing measures that focus on low-income households, over time, there is a chance that excess household savings or liquidity will recede, so the burden on the economy and inflation will be relatively small.
The third concern is longer-term and reflects the structural impact of the epidemic on the economy. Returning to the “post-traumatic” issue, if the epidemic causes a permanent shift in consumption patterns, the world will need to reallocate resources and the workforce will move to sectors where there is still demand, and this shift will be challenging. It is already difficult for the workforce to reskill for new positions, and this shift is likely to increase the need for mobility, which will be another challenge for those with Family or other social ties.
Initially, rising unemployment may remain for some time, leading to a deflationary scenario. However, when governments and central banks mistake high unemployment for a cyclical rather than a structural problem, the threat of inflation will follow. Since the supply forces in the economy are not as large as reflected in the unemployment data, an excess of monetary and fiscal stimulus may trigger inflation.
In this regard, while this challenge is not unique to the outbreak, it is still too early to tell if it will lead to another major policy failure. This concern is clearly not the cause of the recent rise in inflationary expectations in financial markets. Nor should concerns about post-epidemic de-globalization and potential supply chain restructuring be blamed for it. However, in tracking these risks, we will be watching wage growth and inflation expectations closely to see if there are signs of a change in their relationship with the unemployment rate.
Keith Wade, Chief Economist and Strategist, Schroder Investment Management
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