As stewards of capital and investment portfolios, the most important question fund managers face today is whether the 40-year trend of disinflation is ending in 2021? If so, the return of inflation may become a strong market narrative both this year and beyond.
Rampant monetary easing by global central banks to aid the global recovery from Covid-19 is spurring economic activity while debasing fiat currencies. The rising prices of gold and bitcoin are visible indications of this as investors seek to hedge their portfolios against inflation.
Gold is the new zero-coupon bond, a safe-haven asset that doesn’t make interest payments at regular intervals.
The return of inflation, while not the consensus yet, could become the main market theme for 2021, coupled with a rebound in global commodities. This is especially of concern during times when MMT (Modern Monetary Theory) is gaining significant traction with policymakers due to the global pandemic. MMT states that fiscal deficits don’t really matter as long as the government is borrowing in its own currency and inflation is kept under control, a theory that has grown unsettlingly popular post-Covid.
When I say inflation, I’m not talking about 4% inflation, I’m talking about the Fed achieving its goal of averaging 2%. Fed chair Jerome Powell stated that inflation was one of the major challenges of our time.
As the Fed started to distort global fixed income markets by slashing rates to zero while buying corporate bond ETFs, Powell was not referring to too high inflation but rather too low inflation. The Fed’s big rethink in economics is changing minds about public debt.
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The new consensus says governments have more room to spend in a low-inflation world, and should use fiscal policy more proactively to drive their economies. Advocates of MMT say they pioneered these arguments and the mainstream is only now catching up.
My key global macro theme continues to be that inflation will rise by much more than the market consensus anticipates, especially as central banks in developed markets are likely to look the other way. Monetary policy will remain loose combined with an environment with many disinflationary forces of last decade are slowing or reversing (e.g. globalization and low labor costs). Moreover, the distribution of vaccines could spur consumer spending back to pre-pandemic levels which would further increase monetary velocity and drive up inflation.
Policymakers seem to have come to the implicit understanding that inflation is the lesser evil and the only socio-political solution to deal with excess leverage and growing wealth inequality.
Mark Mobius in his timely new book, “The Inflation Myth,” points out that what we believe to know about inflation today does not reflect the reality. Technological innovation that leads to cheaper and better products is not reflected in the ways we measure inflation, Mobius writes in his book. “What we believe to know about inflation today does not reflect the reality any longer.”
Rising inflation will lead to steeper yield curves initially, and eventually policies such as yield curve controls and heavy debt monetization, in my view. This is likely to drive investors into real assets, especially commodities and GEM (global emerging markets). Commodity-rich emerging markets like Russia and Brazil, in my view, are the best hedge against global inflation expectations rising.