Economic reopening, supply shocks and record levels of stimulus are unlikely to unleash 1970s-style stagflation under the supervision of an independent, inflation-targeting central bank that stands ready to act. Furthermore, fiscal stimulus is mainly counteracting the COVID-19 deflationary shock and is also temporary, as U.S. fiscal stimulus will turn to fiscal drag in 2022. This suggests that even though money supply growth has skyrocketed, money velocity is unlikely to meaningfully follow, limiting inflationary pressures (Source: FRED). Finally, the structural headwinds of digitalization, automation and eCommerce, all of which have been accelerated by COVID-19, will allow firms to cut costs and increase productivity. These structural changes along with rising productivity that usually accompanies a recovery are important deflationary forces that are still weighing on inflation.
However, we remain of the view that inflation uncertainty will stay elevated going forward as the economy adjusts to a post-COVID-19 world and the Fed commits to flexible average inflation targeting. Supply shortages and wage growth will be key to watch, especially if shortages persist and productivity growth fails to pick up, as cost-push inflation would be unnerving to investors (as opposed to demand-pull inflation). Shortages however already appear to be waning as shipping and airfreight volumes are picking up and global trade is booming (Source: Bloomberg). It’s important to note that shortages in industries like semiconductors or skill mismatches among workers are nothing new, and previously have not led to sustained price or wage growth.
At the same time, the path to synchronized growth could remain uneven this year amid COVID-19 variants, slow vaccination rates in parts of the world and slow labour market recoveries held back by skill mismatches in an increasingly digitized world. Noisy price pressures and a bumpy recovery generally set up a backdrop of low real yields, which is positive for real assets, from equities and real estate, to gold.