Global vaccine roll out may be helping the economy to recover, yet there are still long ways to go. To alleviate COVID-19 outcomes and drive economic growth, both the U.S. and Europe have taken similar precautions: President Joe Biden’s administration has proposed the third stimulus plan, worth USD 1.9T, while the European Central Bank has allocated a stimulus package amounting to USD 2.2T. Given the hefty stimuli amounts, industry analysts are raising inflation concerns.
There are opposing opinions as to what’s ahead for the post-stimulus economy in the U.S. and Europe: one group siding with the scenario, where inflation is likely, contradicted by inflation naysayers.
Stimulus-Triggered Inflation Potentially Looming Ahead
Economists tend to look for repeating patterns—modeling predictions based on past events. In turn, the concern for the potential inflation for a number of American economists derives from benchmarking The Great Inflation as the anchor historical reference. Back then, the Federal Reserve easy money policies were introduced to spur economic growth and employment rates, unfortunately, resulting in high inflation instead. Now the threat of history repeating itself is fueled by the third wave of ‘easy money’ in the U.S.
History aside, several recent events have triggered the economists’ uneasiness. First, the so-called U.S. economic indicator—10-year Treasury yields—reached its 14-month peak levels (1.776%). As bond yields contribute to the overall economy by setting benchmarks for the rates related directly to businesses’ commercial loans, mortgages, etc., the recent yield growth has been perceived as the first sign of inflation. Should this be the case and the easy money policy turns out to be inflationary and the target inflation goes over 2% target, the Federal Reserve Board might increase the benchmark interest rates pinned near zero before 2023 despite the current plan to keep long-term interest rates low.
Moreover, the stimulus plan passed by the European Central Bank seems to have initiated a chain of events in financial markets by prompting the bond yields to slide and stock markets to rise in European countries. Consumer prices have also started going up in the eurozone with annual inflation rate reaching 0.9% in January.
Other factors contributing to the foreshadowing of inflation are a rising mortgage interest rates in the U.S., potential surge in demand after the lockdown restrictions are lifted, depreciation of the U.S. dollar, and increased commodity prices. Not to mention the investors’ hesitation to purchase bonds as well as the increase of interest rates in bond markets.
Economic Revival Leading to Downfall
The revival of the economy might also be conducive in the potential inflation. The prices of raw materials have been dropping for the last decade, forcing many weaker suppliers out of the market. However, the post-pandemic revival of the economy might naturally increase consumers’ demand for certain goods which would overturn the current balance of supply/demand. The growing demand may then cause the prices for raw materials, as well as end products, to go up.
The increasing prices of raw materials and goods may also be somewhat influenced by investors’ hedging against the inflation by allocating funds between inflation resistant assets (e.g. real estate, grains and meat) and the stock market.
Although stimulus checks directly awarded to citizens constitute only a part of stimulus measures, the risk of inflation is also impacted by the stimulus packages received by countries and state enterprises, which are enabled to borrow funds at low interest rates. After the injection of ‘easy money’, enterprises become inclined to purchase stocks, at the same time increasing the prices of financial measures.
Lastly, one of the less discussed inflation risks that has been a source of worry for investors for some time now is a growing governmental debt. The less funds governments generate through taxes due to the ongoing pandemic, the more investors feel cautious of granting them loans. Consequently, the governments will print more money, which, in turn, will depreciate faster, leading towards inflation.
Inflation Fears Might Be Exaggerated
A large number of industry experts are unruffled by the prospect that stimulus measures might trigger inflation. Biden’s administration and Janet Yellen, Treasury Secretary, have rejected the speculations, adding that the stimulus is not enough for long-term inflation, and the U.S. is now better equipped to deal with potential repercussions. For instance, in consideration of the doubts over the amount of stimulus, the U.S. Federal Reserve has expressed the intention to monitor the situation and maintain low interest rates as preemptive steps.
In Europe, the European Central Bank stays firm in its decision to help the European economies move forwards with the help of the stimulus package. The Central Bank presumably has no concerns for inflation as Christine Lagarde, the bank’s president, suggested the recent increase is due to higher energy prices and other temporary factors. Some of them are attributed to disturbed supply and production chains, decreased demand, OPEC oil production quotas.
Similarly to Lagarde’s statement, experts say there are factors preventing the prices from rising too quickly. Several of them—aging society, rapid technological development, and globalization contribute to both lower consumers’ spending habits and the reduction of prices globally.
The second year of the pandemic is also a key factor acting as a buffer for the inflation. High unemployment rates in both the U.S. and Europe are keeping inflation at bay for a time being as relatively high numbers of unemployed tend to be less active in participating in the consumption chain. As a result, overall spending habits are low, thereby preventing the prices of low-demand items from shooting up. Even with stimulus checks, people might be hesitant to inject the money back into the economy.
Speaking of the positive outcomes of the current situation, controlled inflation under 2.5% helps to drive the economy faster. Minor growth of prices prompt people to spend their funds on goods and services rather than keep them. Also, inflationary economy and currency depreciation in the U.S. would allow federal authorities to allocate a smaller part of the budget to maintaining the federal debt.
For the investors, higher Treasury yields may actually be beneficial for offering increased income and higher return potential. At the same time, investments such as commodities, non-U.S. stocks, or Treasury Inflation-Protected Securities have proved to hedge against inflation in the past.
Wrap up
The end result of stimulus injections still remains to be seen. Multiple factors should be taken into account when considering means to hedge against potential inflation, therefore it is fundamental to maintain a diversified investment portfolio in any of the aforementioned cases.
