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The Wall Street Journal: Everything Screams Inflation

May 05, 2021

Article by James Mackintosh in The Wall Street Journal

We could be at a generational turning point for finance. Politics, economics, international relations, demography and labor are all shifting to supporting inflation. After more than 40 years of policies that gave priority to the fight against rising prices, investor- and consumer-friendly solutions are becoming less fashionable, not only in the U.S. but in much of the world.

Investors are woefully unprepared for such a shift, perhaps because such historic turning points have proven remarkably hard to spot. This may be another false alarm, and it will take many years to play out, but the evidence for a general shift is strong across five fronts.

1)  Central banks, led by the Federal Reserve, are now less concerned about inflation

Since the global financial crisis policy makers have spent much more time worrying about inflation coming in below their targets than above. But recently they have taken decisive steps away from the targets. The Fed has adopted a new, softer target of average inflation of 2%, meaning it can overshoot for years to make up for the past decade’s misses.

Furthermore, it has shifted from focusing on trying to act in advance of inflation based on its forecasts, to waiting until inflation actually arrives. With monetary policy’s effect on the economy famously having long and variable lags behind, as Milton Friedman emphasized, this raises the probability that the Fed acts too late to rein in rising inflation.

2)  Politics has shifted to spend even more now, pay even less later

At least since the Nixon administration, Republicans have been willing to ditch their balanced budget rhetoric when in government. But Donald Trump took this to new levels with a record peacetime deficit to finance corporate tax cuts, even before the pandemic. 

Joe Biden has shown he’s willing to spend still more, and while the next big spending bills come with taxes attached, polls show the public loved the stimulus checks.

Something similar has happened in much of the developed world. The lesson of the post-financial crisis austerity was that it didn’t work, and stimulus was withdrawn too quickly. Politicians naturally prefer the joys of spending and are unlikely to repeat the post-2009 mistake, so adding to inflationary pressure.

Near-term inflation pressures from post-pandemic spending combined with restricted supply could be the start of the broader shift. But inflation might fall back again before the bigger trends become established. Even a decade after the last turning point, when Paul Volcker, Fed chairman, quashed inflation at the expense of a deep recession, annual price rises again passed 6%. Few then would believe that inflation had been beaten for a generation, but it had.

If we are at a turning point, the cost of being wrong is high. Investors who are buying 10-year Treasurys at 1.6% will lose horribly from higher inflation. Even hitting the Fed’s target of 2% over the period would mean a loss of spending power.

If inflation picks up to the 1990s average of 3% it would be extremely painful, and if fears took hold that 3% could turn into the 1980s average above 5%, Treasurys would be massacred.

It is too soon to go all-in on the idea that inflation is inexorably headed higher. But it would be crazy to build a portfolio that didn’t consider inflation a major risk .....

To read this article in The Wall Street Journal in its entirety and view the relating charts, click here.

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