Inflation's Sting May Return (But Not Quite Yet)

$8 Trillion!

From our friend David Rosenberg this morning: "Why aren't markets getting hit even more (as in equities)? ... Governments around the world have stimulated so much, that's why. Just on the fiscal side alone, not including all the incursions by central banks alone to influence and support risk-asset prices, the global stimulus has come to an astounding $8 trillion."

This is going to make the Bank of Canada's inflation projections (as I suggested in Tuesdays blog) go squirrelly!

From the BOC's April Monetary Policy Report:

"The weak economic outlook will weigh on inflation. Because of severe and adverse effects of the pandemic, there is considerable uncertainty around the outlook for inflation. Determining the impact of the economic contraction on future inflation is difficult because both supply and demand are falling. There will also likely be technical challenges to measuring inflation during the containment period."

Gas and other energy related prices have fallen precipitously, especially those pertaining to transportation and travel (hotel costs too). Likely food and medical prices have risen on scarcity and perhaps delivery costs, although with folks no longer dining out, that could be a wash.

But, what happens when the recovery comes (and how sustainable it might be)? All that stimulus sloshing around is going to impact the value of our money. Already it can be seen in the little watched (anymore) money supply numbers:

Back in the late 1970's / early 1980's when inflation was peaking at 9% annually (only those of us over 60 likely remember this era) this was a key data point and we currency, money market and bond traders waited for the weekly reports in order to assess the central bank's next likely interest rate move in their raging battle against inflation. Higher levels of money supply in the system were considered inflationary, prompting expectations of central bank tightening of monetary policy (higher interest rates).

We are going to start to need to keep an eye on this again because of the potential for it to sneak up on us. Central banks money printing presses are running on overdrive.

History tells us that after recessions, inflation will inevitably return and become the next worry. The last thing highly indebted economies need is a surge in interest rates to combat the upward inflationary pressures. Bond and fixed income investors will demand inflation premiums to be built into yields if they perceive erosion of purchasing power in the future. The big debt load put on governments who will be borrowing to finance the $8 trillion in stimulus will also add to long term interest rate increases. The market will determine the level of interest rates, but it would have implications for mortgage rates too, as they are set off of what happens in bond markets. 

If safer investments provide a better return than riskier stocks, where will aging investors feel more comfortable? 

It is also going to challenge the central banks whose mandates are based on controlling inflation (the value of their currency).

How this plays out is far from certain, but it could have significant consequences for all of our collective Wealth Forecasts should we have to ramp up our assumptions surrounding our annual cost of living increases.