Inflation Next?
We are in uncertain times, and the next 6-months should be an interesting ride. The pandemic that effectively shut down the economy for the past 3-months continues to persist through the US. The government has been swift in distributing stimulus to small businesses, however for many businesses this stimulus will only serve as a band-aid offering short-term relief. As businesses reopen some will return to normal operations and even get a surge in pent-up demand, while others may never reopen, especially in the retail & hospitality space.
We can be hopefully that the majority of businesses will return to normal, and consumer spending will pick up again, as it accounts for 70% of the economy. The Fed has said that it is prepared to do anything to support the economy. The Fed Balance Sheet stood at $3 trillion dollars one year ago, and it is now at $7 trillion, with expectations of it going as high as $10 trillion in fighting off the recession.
We have never seen a Central Bank response such as this, and only time will tell if it translates into a steep increase in inflation. You may argue it is already causing asset inflation, which could explain the large dislocation between the economy and the stock market. If you are left scratching your head at what appears to be a booming stock market with the backdrop of a stuttering economy with massive unemployment, the Fed actions might explain it. When the Fed turned on the printing presses, vacuuming up Treasury Bills and Corporate Bonds, they suppressed the Fixed income yields available in the market. Invested money seeking yield has nowhere else to go but equities, and hence the stock market keeps climbing. I could be totally wrong, the stock market is always future looking and the smarter people out there could be seeing a much quicker recovery.
For the moment, with so much stimulus pumped into the market, it is hard to accurately gauge what damage may have been done on Main Street. I anticipate plenty of retail & hospitality failures, which will have a knock on effect to landlords, and then banks. Banks are in much better shape than 10-years ago, and have much more capital and liquidity to weather a significant impairment to their loan books. However, if the unemployment number remains high for too long, it will also affect consumer spending and residential mortgages. This knock on affect would be more severe. Already 10% of all home mortgages, representing $1 trillion, are on a deferment plan. Without a significant & quick improvement in employment numbers, this deferment number could turn into an impairment number on the bank's balance sheets.
On the positive side, a lot of businesses have been able to remain functional through the pandemic. With advances in technology allowing a seamless transition to working from home. Had this happened 20-years ago the affect on productivity would have been much worse. The pandemic may have accelerated the adoption of remote working by a decade. There will be many business winners & losers coming out of this. On balance, hopefully as a whole the economy can return to growth quickly.
The Fed response was quick and necessary. Unfortunately, heading into this recession their interest rates were already too low, and their balance sheet too big. It left little room to maneuverer with an effective interest rate response. In recessions past, the Fed typically had the luxury of a 5% interest rate cut without going negative. They did not have that cushion this time. Instead they resorted to a return to Quantitative Easing, in other words buying Treasuries & Bonds. Time will tell if this massive stimulus and printing of money increases inflation significantly.
What better hedge against inflation than buying investment real estate, and locking in today's extremely low interest rates!
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