First Reflation, now Stagflation, the cost of Covid 19
Whilst we continue to try and assess the ongoing social and economic costs of this pandemic, inflation has become a key concern for financial markets as it broadens while growth recedes. This unusual mix is in part driven by a lowering of economic support and lack of supply normalization, as the world grapples with differing re-opening strategies and trade channels remain logjammed.
Over the past 3-4 months, investors have witnessed a significant acceleration of inflation that is steadily broadening and running ahead of expectations. At the same time, as the initial sugar rush subsided, economic indicators globally are surprising in many cases to the downside. While we are far from stagflation – high inflation, a complex unemployment situation and stagnant demand is close enough.
The answer in part to the inflation problem will be how well governments coordinate with the private sector in solving the current bottlenecks. In the US, Jo Biden has just announced a deal with Los Angeles ports for their workforce to be able to be open 24/7, designed to address some of these supply backlogs. It remains to be seen what impact this will have, if any and at what cost. Similarly, initiatives proposed suggesting that governments subsidise people to go back into the workforce to reduce the labour market shortages currently being experienced (truck driver shortages in the UK). However, political solutions (whether you agree with them or not) are often protracted and you run the risk of an extended inflation increase as many of these issues are debated.
In terms of supply chain issues, I find myself more confident that private enterprise will find solutions and free market conditions will return at some point. However, I was expecting a gradual normalization of demand and supply, but to this point this has not occurred. Demand has been artificially supported but supply has not normalized as economies haven’t yet properly opened, with regular lockdowns and re-openings impacting supply of labour (from truck drivers to nurses) while constraining ports and facilities.
So, what if inflation stays intense and isn’t transitory? This would lead to a wholesale repricing of all assets as interest rates will need to be lifted to stem the tide. To my mind, and I have written at length previously, simply raising interest rates is too blunt an instrument and the risk of financial instability too high. Whilst I support the need to start normalizing interest rates over a measured timeframe, both the public and private sector are going to need to think more laterally or run the risk of destabilizing an already uncertain economic recovery.