Powerful shots of stimulus from governments and central banks will push up inflation once the immediate Covid-19 crisis fades, according to some high-profile fund managers.
At the moment, most money managers and economists reckon deflation is the more immediate risk. The eruption of mass unemployment, stay-at-home orders and social distancing together constitute one of the biggest shocks to economic demand in history.
Yet some investors argue the real longer-term threat is the return of inflation, as policymakers’ dramatic interventions to prop up demand ultimately drive up prices.
“We are witnessing the ‘great monetary inflation’ — an unprecedented expansion of every form of money unlike anything the developed world has ever seen,” Paul Tudor Jones, head of Connecticut-based Tudor Investment Corporation, said in his latest letter to investors. “High debt accommodated by money printing is difficult to banish. Inflation expectations could one day respond to this reality.”
Hedge fund manager Crispin Odey also expects inflation to get “pretty red hot”. The founder of London-based Odey Asset Management is reluctant to bet on such an outcome, as long as economies are in lockdown and the markets remains focused on the threat of deflation. But he argued inflation is ultimately unavoidable given the level of stimulus.
The disruptive effects of Covid-19 on global supply chains will also help stoke price increases, said David Einhorn, the head of New York-based Greenlight Capital.
“Opportunistic price-gouging on toilet paper, hand sanitiser, milk, rice and potatoes is not a signal of broad inflation. However, a country that consumes much more than it produces, financed by ongoing money creation, will have more money chasing fewer goods and services,” Mr Einhorn wrote to investors earlier this month. “Once the initial shock wears off and the recovery begins, the inflation will begin to show up.”
This remains a minority view, but it is one that is starting to attract some attention. More than 1,100 listeners tuned in to a Morgan Stanley webcast this week when the bank’s analysts presented a case for inflation staging a comeback. That is about double the audience for a typical webcast.
“Just as the consensus underestimated the disinflationary trends of the past 30 years, it is at risk of underappreciating the inflation threat,” Chetan Ahya, Morgan Stanley’s chief economist, said in a report. “I would argue that the driving forces of inflation are already aligned and a regime shift is under way.”
Over the past three decades, inflation has been held in check by technological advances, globalised trade and the rise of multinational companies that have outsourced production and hamstrung workers’ ability to extract higher wages. Those factors could reverse in the coming years, said Mr Ahya, and help propel inflation above central banks’ targets by 2022.
Market indicators such as subdued government bond yields suggest that few investors think inflation is a real danger. US five-year inflation swaps — a closely watched gauge of investors’ expectations of price rises over the longer-term — have rebounded from their March lows but remain around 1.7 per cent, below the Federal Reserve’s target of 2 per cent. The equivalent measure in the eurozone is just 0.87 per cent.
Some say central banks’ vast bond-buying programmes are distorting the markets’ usual signals on the path of prices. But many investors are wary of committing to bets on rising inflation given their experience of the aftermath of the 2008-09 crisis, when years of extraordinary stimulus did not lead to a surge in consumer prices.
Unlike in 2009, few investors are placing “high-conviction bets” against government bonds in anticipation of inflation, said a senior trader at one of the top bond-dealing banks. “The market is clearly not worried about inflation pressures currently, but you worry slightly that investors are still fighting the last crisis,” the trader said.
Other analysts are sceptical. Given the indebtedness of many companies, the economic shock from the coronavirus outbreak could instead trigger a self-reinforcing spiral of deflation and defaults, according to Matt King, a Citigroup strategist. “At best, the debt overhang and desire to rebuild buffers will have long-lasting deflationary consequences,” he said. “At worst, defaults will feed on each other.”
Inflation sceptics also point to Japan, where despite decades of hyperactive monetary policy from the central bank, prices have rarely risen with any consistency.
Mr Tudor Jones argued that the struggling Japanese banking sector and the sluggishness of policymakers’ initial response caused deflation to become entrenched. Moreover, growth in Japan’s monetary base has never approached the rapid levels seen in the US today, which is expanding at the fastest pace since World War II, according to Tudor’s estimates.
The hedge fund manager conceded that inflation will likely slide in coming months. But he is betting that even when the most intense phase of this crisis has passed, governments will struggle to wean themselves off central bank-financed spending — something that economists dub “fiscal dominance”. This, he argued, could revive inflation as the global economy recovers.