“First and foremost, we should remember that this time a year ago the market was more concerned about disinflation. And there are powerful forces in the modern economy which have been keeping inflation low for decades – globalization, aging populations and technology, for example. You’ve got to be pretty confident that something is very different in the global economy before getting too worried about inflation. That said, something has changed and I am getting more open to the possibility of a more inflationary environment than we’ve seen over the past few decades.
“Not only has the world seen stimulus of a record scale, but this stimulus is far more concerned than that in previous cycles: for example, after the 2008 crisis, while we saw plenty of expansionary monetary policy from central banks, fiscal policy was generally restrictive as governments pursued policies of austerity. In a way this time really is different: governments and central banks are pursuing expansionary policy objectives together far more blatantly than ever before. On the back of this, it seems likely we can expect a fairly significant rebound in demand in 2021 given that many households are in a reasonably strong financial position (though many are not) with pent up demand. In the shorter term, there will also be some base effects from low commodity prices in 2020 (e.g. oil) and shipping container shortages, while looking ahead the US minimum wage and rise in global food prices are inflationary factors too.
“Likewise, if we do see inflation begin to pick up, I do think central banks will be far more hesitant in tightening financial conditions than we are used to. We have already seen the Fed move from targeting 2% inflation to targeting a long-run average, giving them the freedom to allow inflation to run a little high after a period of lower inflation. And, with government debt at near record levels, there is a clear incentive to keep short term policy rates anchored down for some time.
“The big question for me though is the extent to which long-term damage has been done to the economy. Is the assumption that the many unemployed and on furlough will simply walk back into their jobs well-founded? Or did 2020 accelerate an already-changing economy and lead to the permeant decline of certain sectors (most obviously high street retail) and to ways of working that will lead to far lower price competition in cities? My concern is that we may see more hysteresis in the economy than the market is pricing in.
“In my funds, I have bought TIPS and some other inflation-linked bonds recently, as well as begun to scale into some commodity-correlated currencies – not as a big conviction call on the return of inflation, but as some upside insurance for the reflation we are likely to see this year and possibly stronger inflation over the medium term.”
