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At Barron’s, Randall W Forsyth explains that “war” spending in the battle to fight the effects of the coronavirus could spark higher inflation. He writes:
Wartime finances that balloon budget deficits and that are covered by money-printing have proved inflationary throughout history.
At the same time, globalization—already in retreat in the trade wars—will be curtailed further, as supply chains are relocated to avoid crossing borders, rather than to maximize comparative advantage. That will raise the cost of internationally traded goods at a time when prices of services already are moving higher.
While the coronavirus pandemic might seem to be an odd time to be thinking about inflation, writes Julian Brigden of Macro Intelligence 2 Partners, he sees the crisis accelerating the “generational inflection point” in macroeconomics. “But we are now entering an era of monetarily financed fiscal policy, just as the trend to de-globalization accelerates. This is going to be very inflationary,” he writes.
Similarly, Mathieu Savary of the Bank Credit Analyst contends that “Covid-19 has generated an inflationary shock in the medium term.” In addition to the wartime-style budget responses, funneling cash from central banks directly to consumers will be more inflationary than the quantitative-easing programs undertaken to respond to the financial crisis, he argues.
The bottom line: Brace for higher inflation. That means eschewing bonds, which Savary says “display rock-bottom real yields, inflation protection, and term premia” (the extra yield for the risk of holding long-term securities). Similarly, Brigden thinks the only refuge for fixed-income investors is in “inflation break-evens” (the difference between the nominal yield on Treasury notes and TIPS, or Treasury inflation-protected securities).
Savary says stocks should outperform bonds, not through superior real returns by equities, but because of poor performance by bonds. Gold has probably begun a new structural bull market, he writes, from higher inflation and lower real interest rates, while “easy fiscal policy and money-printing will devalue currencies versus hard assets.” Emerging market equities benefit from strong real asset prices, and provide “imbedded inflation protection.”
So don’t worry that the coronavirus crisis will hurt the credit of Uncle Sam. Instead, prepare for a world very different from that of the past four decades, with rising inflation and interest rates.
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