The inflation debate shaking US markets in the face of the 2021 test

Photographer: Graeme Sloan / Bloomberg

They are still in the minority, but investors and economists who think America is in a period of inflation – perhaps severe – are starting the year with new weapons for their arguments.

Vaccines offer the prospect of ending pandemic restrictions that could bring consumers back. That’s what economists call pent-up demand – a label that literally applies right now. The new Biden administration is likely to support household spending with more financial aid, after this month’s Senate elections gave Democrats a majority. And in the background, the dollar is weakening and commodity prices have been rising steadily for months.

All of this has pushed up the bond market’s measures of expected inflation. The said break even 10-year Treasury bill rate climbed above 2% last week to its highest level in more than two years.

Yet the prevailing view among economists – including, most importantly, the Federal Reserve – is that it will be years before the United States has to worry about inflation.

Data due Wednesday is expected to show that consumer prices rose 1.3% in 2020. With rising costs to producers, almost everyone is predicting a higher rate this year. But even by the end of 2022, the Fed’s preferred measure will not exceed its 2% target, according to economist polls. And Fed officials say they want to see inflation stay above that level for a while before raising interest rates.

Inflation skeptics point out that labor markets are still depressed by the virus, deeper demographic and tech trends that are keeping prices down, and the risk that politicians will interrupt support for the economy too early – as they did in the recent past.

So is inflation on its way back? Here are some of the main arguments from each side.

Yes, because: the pumps are primed …

The policy settings just got changed even more towards the “run-it-hot” end of the dial. Budget spending has been the engine of the recovery from the coronavirus crisis, and President-elect Joe Biden – who promises to do more – has a clearer path to pushing his plans through Congress after Democrats won the two Senate seats in January. 5 vote in the second round in Georgia.

“Biden’s agenda is on the line again, which means even more fiscal expansion in the near term,” says Aneta Markowska, chief economist at Jefferies. She expects 10-year Treasury yields, which topped 1% last week for the first time since the pandemic hit in mid-March, to reach 2% by the end of the year. ‘year.

Meanwhile, the Fed, which can’t do much to speed up the economy right now, remains in charge of the brakes – and promises not to hit them anytime soon. After consistently falling short of its target, the Fed’s new policy is to let inflation exceed and stay there – so on average 2% over time – before raising borrowing costs to calm things down. .

… V is for vaccines…

United States. The economy has moved closer to a V-shaped recovery than it seemed likely earlier in the crisis, and vaccines could complement the job.

Americans are already spending more on goods than before the virus. If that’s not yet the case with the services, it’s only because lockdowns have taken away options from consumers – which is expected to change as more people are vaccinated.

Morgan Stanley economists expect “a strong rebound in demand, especially in Covid-sensitive sectors such as travel and tourism”, as vaccines will be more widely deployed in the spring. They predict that core inflation, which excludes the prices of commodities like food or gasoline because they are more volatile, will hit the 2% threshold this year and exceed it in 2022.

… And households are flush with

Stimulus checks and higher unemployment benefits have pushed up household incomes overall even as economic output fell – a rare combination. And rising stock and real estate markets helped add more than $ 5 trillion to U.S. household net worth in 2020.

High-income people and the elderly, more likely to self-quarantine, have accumulated savings while waiting for the pandemic, says Mark Zandi of Moody’s Analytics. They’ve missed out on things like trips to the hairdresser, vacations, and out-of-town meals – and they’re “in an uniquely good financial position to increase spending on these services once they get there. feel sure.”

No, because: this time it’s no different …

The gradual disappearance of inflation is one of the most entrenched trends in the economy. And the political response of all hands at the pump to the pandemic is not entirely unprecedented. After 2008, the government and the Fed also pumped money into the economy, causing many to predict inflation that never happened. Budget spending has been bigger this time around, as has the hole in the economy it needed to fill, so the result won’t necessarily be overheating.

This decade so far looks a lot like the last, says Ben May of Oxford Economics. “Insufficient demand has been countered by looser monetary and fiscal policy. This boosted asset prices, but core consumer price inflation remained low. “