By Matthias Scheiber, Global Head of Multi-Asset Solutions at Wells Fargo Asset Management
The word “inflation” seems to be in the air these days. Prices for lumber, food, used cars, gas—you name it—are all up significantly over the past year. Companies are complaining about sky-high shipping rates, semiconductor shortages, and the difficulty of filling open positions at any wage. Perhaps the biggest question on the minds of investors now is whether these price pressures are fleeting in nature or more permanent. Our analysis points to a reflationary, upward swing in economic growth and inflation expectations following the pandemic, which is creating a transitory inflationary environment that will play out over the next 12 to 18 months. This paper explains our view.
Policy responses are a big part of what is driving price pressures. It is informative to look back at the last major policy responses following the global financial crisis (GFC) for precedent. We begin our analysis by highlighting some important differences with today’s environment. Another point of reference is the market’s view—how do our expectations differ? Finally, what are some of the factors that will inform the evolution of our views? We can summarize the main factors here:
• The market’s confidence in central banks’ ability to manage inflation expectations
• Corporations’ ability to manage bottlenecks and pass-through costs to their customers
• The impact of debt dynamics and savings
• How productivity improvements may be able to absorb inflationary pressures
This is not meant to be an exhaustive list. However, we think this is important groundwork to lay to inform investors how to plot a prudent course in asset allocation and to spot opportunities in various capital assets on a go-forward basis.
How did the policy response to the COVID-19 crisis compare with the response to the GFC?
The monetary and fiscal impulse has been enormous during the past 1.5 years. The Federal Reserve’s massive asset purchases have ballooned its balance sheet and relief and stimulus programs have ballooned the federal government’s debt. The last time the Fed’s balance sheet and the federal debt grew at this pace or faster was in the wake of the GFC of 2008–2009. Back then, short-term government securities yields dropped to 0%, and in some cases, like in the eurozone and Japan, yields eventually dropped below 0%.
The response to the COVID-19 crisis has differed in terms of the timing, scale, and focus of fiscal policy. Policymakers were very fast in responding to the COVID-19 crisis compared with how long it took to roll out fiscal support during the GFC. Figure 1 shows the difference in the scale of the stimulus—the COVID-19 crisis commanded a combined fiscal and monetary response of 20% of gross domestic product (GDP) in the eurozone, 27% in the U.S., and up to 54% in Japan. For comparison, this dwarfed the fiscal support during the GFC, which ranged from a “mere” 1% to 6% of GDP across these regions.