Via Morgan Stanley:
#1 – The V-shaped recovery: A key part of why MS expects inflation to emerge is because it anticipates a sharper but shorter recession. At its core, this recession was triggered by an exogenous shock in the form of a public health crisis. Coming into 2020, there wasn’t an excessive leverage build-up in the private sector and the banking system was in better shape than it was in 2007. This means that deleveraging pressures are more moderate and the financial system can still play its role as a key intermediary, unlike post-2008. Morgan Stanley therefore expects global and DM output levels to reach pre-COVID-19 levels by 4Q20 and 4Q21, respectively.
#2 – The policy response is very different… According to Morgan Stanley, “the policy response also matters in shaping the growth and inflation outlook and it has been timely, sizeable and coordinated (both monetary and fiscal easing).” The fiscal response in particular has been far more aggressive and quicker because, as the chief economist amusingly puts it “the recession is nobody’s fault” (and what if it had been, would the response be any different). A large fiscal response is important because monetary stimulus, expansionary as it is, would not be adequate to lift aggregate demand on its own. Interestingly, the recognition of this issue was growing before 2020. Hence, policy-makers knew that they had to act quickly on fiscal policy (almost as if they welcomed the covid shock). Moreover – and just to repeat the most amusing aspect of this entire argument – Ahya once again notes that “this time around, there were also lesser moral hazard concerns simply because the shock was exogenous.”
…and the use of active fiscal policy is here to stay: Next, the MS economist writes that “policy-makers were increasingly concerned about rising inequality and they recognised that monetary policy was a blunt tool which is not able to address the distributional effects”, if only they could recognize that their policies actually accelerated this rising inequality. The GCR exacerbated these concerns and left a deep scar on lower-income households. At the peak of the COVID-19 shock, 70% of the job losses in the US were in the low-income segments. Hence, the focus on unemployment and impact on lower-income households will mean that expansionary policies will remain in place for longer. Policy efforts to address inequality, and this we do not disagree with “will impart an inflationary impulse, particularly if the mix is skewed towards transfers to households.”
#3 – Risk of scrutiny of the interplay between tech, trade and titans will persist: Policy-makers’ “focus on inequality” will also mean that efforts to restrain trade could continue while there are risks of increased scrutiny of tech and titans. Trade tension is one such example, in which policy-makers had already begun to check the impact of globalization on inequality. However, as the interplay between this trio of tech, trade and titans has been a key driving force of disinflation in the past 30 years, disentangling them will also lead to a shift in the inflation dynamics.
#4 – Central banks are doubling down: At the same time, central banks – which supposedly are so very concerned about rising inequality (which their actions have caused) “have doubled down on their commitment to achieving their inflation goals.” The Fed is already emphasizing the symmetry of its 2%Y inflation goal (meaning after its September review, the Fed will go all-in on further debasing the dollar). Market-based real rates have already declined significantly, and a shift in strategy will allow the Fed to provide more accommodation.
…this confluence of factors has already led to a very different outcome for US inflation breakevens. They did not decline to the levels seen post the GFC and have also rebounded in a quicker manner to pre-COVID-19 levels.
Just as the effects of deleveraging were underappreciated post-2008, we think that the effects that this Great COVID-19 recession will have on inflation dynamics are also not as well understood, with most investors still very much in the disinflation camp. But when we look back at 2020, it may well be that the most important structural change that COVID-19 gave rise to from a macro perspective will be this structural shift towards higher inflation.
The divers of lowflation are:
- debt saturation, ZIRP and zombification leading to chronic oversupply;
- inequality leading to demand deficit and chronic oversupply;
- generational bust leading to demand deficit and chronic oversupply.
- the rise of EM and China malinvestment models leading to chronic oversupply in trade;
- Europe’s savings growth model leading to demand deficit and chronic oversupply.
Fiscal can overturn the first three in theory but not until it turns full-blown MMT. We are still only scratching the surface on that and it will take a revolution in thinking that is struggling.
Repratriation of China-based supply chains will help with the fourth but not that much given other EMs will be the prime beneficiaries. The last one is a lost cause.
In short, I am not convinced.
