The month of August ended with a paradigm shift in the monetary policy framework of the Federal Reserve. Chair Powell announced a move to ‘average inflation targeting,’ whereby the Fed would allow an overshoot of inflation beyond its 2% target to make up for periods of weak inflation. One of the main purposes of such a move is to raise market expectations for the future level of inflation. As Powell stated: ‘Longer term inflation expectations, which we have long seen as an important driver of actual inflation and global disinflationary pressures, may have been holding down inflation more than was generally anticipated.’
The potential risk of high inflation is a topic that has divided the investment community. What is certain is that COVID induced lockdowns have created immense deflationary pressures. GDP figures, released earlier in the month, confirm that the second quarter has been the worst ever recorded in modern history. Real GDP among OECD economies contracted by an average of -9.3% in Q2, far worse than at the height of the Global Financial Crisis (GFC) in Q1 of 2009 (-2.3%). With such a large output gap and elevated unemployment rates, as well as record low levels of capacity utilisation across major economies, it is hard to envision an overshoot of inflation above the 2% level in the immediate future. Additionally, the pandemic has accelerated the digitisation of the economy across many sectors, which adds to the disinflationary pressures in the long run.
However, those who argue for inflation will point to record levels of growth in M2 money supply, which tracks the level of cash, deposits and money market securities in the economy. Contrary to the GFC, this crisis has prompted a coordinated monetary and fiscal response, which has left households and corporations sitting on ample levels of cash. M2 has risen a record 23% YoY, more than double the peak during the GFC. As noted in previous commentaries, the personal savings ratio across major economies are at record highs. Some of these savings have undoubtedly fueled the recovery in housing and stock markets, where aggregate prices are now above pre-pandemic levels in the US. The future path of CPI inflation will depend upon how rapidly this extra disposable income is spent on goods and services in the wider economy. Although the money supply has increased, money velocity, which tracks the frequency of transactions in the economy has collapsed.
Follow the consumption trail
Boosting consumption has been the primary focus of UK Chancellor Rishi Sunak after a devastating collapse in output in the second quarter. Real GDP contracted -20.4% in Q2, the sharpest fall amongst the G7 nations. This was more than double the contraction in the US (-9.3%) and Japan (-7.8%). GDP in France, Italy and Germany fell by -13.8%, -12.4% and -12% respectively. GDP statistics are of course backward looking and fail to reflect real time economic activity, which has been extremely volatile and almost impossible to forecast during this crisis.
The dismal second quarter is likely to be followed by a record breaking third quarter after fiscal measures have encouraged a rebound in consumer spending. The government’s ‘Eat Out to Help Out’ scheme launched earlier this month and was preceded by a 5% VAT cut in July for the battered hospitality sector. Retail sales are now 1.4% above the level in July of last year. To refill the government coffers, tax increases on the wealthy, pensions and companies have been suggested as being part of the upcoming Autumn budget. Public borrowing could do with additional support given the Office of Budget Responsibility estimates the deficit could top £370bn by the financial year 2020 / 2021. Nevertheless, uncertainties around the future path of the virus and the release of a vaccine remain.
Stimulus or no stimulus?
Given the policy driven nature of the recovery so far, the lack of progress on a renewed fiscal package in the US is cause for concern. The $600 a week in unemployment benefits has expired with unemployment still above 10%. In terms of the absolute fall in income, Treasury payouts to the unemployed have fallen by over 50% since the beginning of August, around $10bn a week. With Congress in recess until September, President Trump has attempted to force through legislation with a series of executive orders. However, these proposed measures do little to offset the fall in income. The total level of funding for unemployment benefits is only $44bn, which would be depleted in a matter of weeks, even if payouts are halved from $600 to $300. Uncertainties in the US outlook remain given the delay in the fiscal support package, expected volatility ahead of the upcoming election and how the US market has been led by a narrow section of the market.
How will countries handle bankruptcies?
In assessing the long-term damage to growth from the coronavirus, we continue to observe the path of bankruptcies across major economies. As was the case following the GFC, both Europe and the US have adopted opposing strategies in how they deal with failing businesses. In the US, 45 companies with assets over $1bn have filed for bankruptcy year to date. This exceeds the 38 companies who filed during the same period in 2009. On the other hand, new bankruptcy filings in Europe have fallen relative to filings last year before the pandemic hit. Governments in Europe have either suspended bankruptcy court proceedings or waived the obligation for pandemic hit businesses to file. Bankruptcies can lower the potential growth rate of an economy as labour demand and capital investment is destroyed and not easily replaced. However, the pandemic has accelerated the downfall of companies that were arguably already heading for bankruptcy. In this sense, allowing weaker companies to fail can create room for more productive firms to fill the gap. Such trends have certainly taken place in the retail sector. The risk for the European economy lies in the creation of more ‘zombie firms,’ that continue to exist and drag down the productive capacity of the economy.
Originally Posted in September 2020 – High Inflation Risk is Dividing the Investment Community
This document issued for marketing and information purposes; in the United Kingdom to professional clients by Pyrford International Ltd, which is authorised and regulated by the Financial Conduct Authority; in the EU to professional clients by BMO Asset Management Netherlands B.V., which is regulated by the Dutch Authority for
the Financial Markets (AFM); in Switzerland to non-qualified investors by BMO Global Asset Management (Swiss) GmbH, which is authorised and regulated by the Swiss Financial Market Supervisory Authority (FINMA); in Hong Kong to professional clients by BMO Global Asset Management (Asia) Ltd, which is authorised and regulated by the Securities and Futures Commission; in Australia to wholesale investors by BMO Global Asset Management (Asia) Ltd, which is authorised and regulated by the Securities and Futures Commission in Hong Kong, and is exempt from the requirement to hold a financial services license under the Corporations Act in respect of financial services it provides to wholesale investors in Australia; in the USA to institutional investors by BMO Asset Management Corp. a SEC registered investment adviser.
Pyrford International Ltd is authorised and regulated by the Financial Conduct Authority, entered on the Financial Services Register under number 122137. In the USA Pyrford is registered as an investment adviser with the Securities and Exchange Commission. In Australia Pyrford is exempt from the requirement to hold a financial services license under the Corporations Act in respect of financial services it provides to wholesale investors in Australia. In Canada Pyrford is registered as a Portfolio Manager in Alberta, British Columbia, Manitoba, Ontario and Quebec. Pyrford is a wholly-owned subsidiary of BMO Financial Group, a company listed on the Toronto Stock Exchange (ticker BMO).
Past performance is not a guarantee of future results.
All investments involve risk, including the possible loss of principal.
This report is for general information purposes only and is not intended to predict or guarantee the future performance of any investment, investment manager, market sector, or the markets generally. The information contained herein is not, and should not be construed as, investment, tax or legal advice to any party. Investments should be evaluated relative to the individual’s investment objectives and professional advice should be obtained with respect to any circumstance. We will not update this report or advise you if there is any change in this report. The information is based on sources believed to be reliable. We do not represent or warrant that the report is accurate or complete.
This presentation may contain targeted returns and forward-looking statements. “Forward-looking statements,” can be identified by the use of forward-looking terminology such as “may,” “should,” “expect,” “anticipate,” “outlook,” “project,” “estimate,” “intend,” “continue” or “believe” or the negatives thereof, or variations thereon, or other comparable terminology. Investors are cautioned not to place undue reliance on such returns and statements, as actual returns and results could differ materially due to various risks and uncertainties. This material does not constitute investment advice. It does not have regard to the specific investment objectives, financial situation and the particular needs of any specific person who may receive this report. Investors should seek advice regarding the appropriateness of investing in any securities or investment strategies discussed or recommended in this report and should understand that statements regarding future prospects may not be realized.
Investment involves risk. Market conditions and trends will fluctuate. The value of an investment as well as income associated with investments may rise or fall. Accordingly, investors may receive back less than originally invested.
Investments cannot be made in an index.
Disclosure: BMO Global Asset Management
This website is for informational purposes only and is not intended to provide a complete description of BMO Global Asset Management’s products or services. Past performance is not indicative of future results. It should not be construed as investment advice or relied upon in making an investment decision. Information on this website does not constitute an offer for products or services, or a solicitation of an offer in any jurisdiction in which such solicitation or offer would be unlawful. Products and services can only be offered by appropriate representatives of the respective manager. Notice to residents of the United Kingdom: For the avoidance of any doubt, the information on this website does not constitute an offer for products or services to persons in the United Kingdom.
BMO Asset Management Corp. is the investment adviser to the BMO Funds. BMO Funds are distributed by Foreside Financial Services, LLC.
All investments involve risk, including the loss of principal.
Foreign investing involves special risks due to factors such as increased volatility, currency fluctuation and political uncertainties.
Investors should carefully consider the investment objectives, risks, charges and expenses of the BMO Funds. This and other important information is contained in the prospectuses and/or summary prospectuses, which can be obtained by calling 1-800-236-3863. Please read carefully before investing.
BMO Global Asset Management is the brand name for various affiliated entities of BMO Financial Group that provide investment management and trust and custody services. Certain of the products and services offered under the brand name BMO Global Asset Management are designed specifically for various categories of investors in a number of different countries and regions and may not be available to all investors. Products and services are only offered to such investors in those countries and regions in accordance with applicable laws and regulations. BMO Financial Group is a service mark of Bank of Montreal (BMO).
BMO Asset Management U.S. consists of BMO Asset Management Corp., BMO Asset Management (Canada)® includes BMO Asset Management Inc.
BMO Taft-Hartley Services and BMO Trust and Custody Services are a part of BMO Global Asset Management and a division of BMO Harris Bank N.A., offering products and services through various affiliated entities of BMO Financial Group.
Investment advisory services in the United States are provided by BMO Asset Management Corp., BMO Asset Management Limited, LGM Investments Limited, BMO Global Asset Management (Asia) Limited, Pyrford International Ltd and Taplin, Canida & Habacht, LLC.
Investment advisory services in Canada are provided by BMO Asset Management Inc., BMO Asset Management Corp., LGM Investments Limited, BMO Global Asset Management (Asia) Limited and Pyrford International Ltd.
Financial promotions in the United Kingdom are provided by LGM Investments Limited, Pyrford International Ltd, and BMO Asset Management Limited. LGM Investments Limited, Pyrford International Ltd, and BMO Asset Management Limited are authorized and regulated by the Financial Conduct Authority in the United Kingdom.
Asset management services in Hong Kong are provided by BMO Global Asset Management (Asia) Limited, licensed by the Securities and Futures Commission to conduct regulated activity Type 9 – asset management under the Securities and Futures Ordinance.
Investment products are: Not a Deposit — Not FDIC Insured — No Bank Guarantee — May Lose Value.
Copyright © 2021. BMO Financial Corp. All Rights Reserved.
TM/® Trade-marks/registered trade-marks of Bank of Montreal, used under license.
Disclosure: Interactive Brokers
Information posted on IBKR Traders’ Insight that is provided by third-parties and not by Interactive Brokers does NOT constitute a recommendation by Interactive Brokers that you should contract for the services of that third party. Third-party participants who contribute to IBKR Traders’ Insight are independent of Interactive Brokers and Interactive Brokers does not make any representations or warranties concerning the services offered, their past or future performance, or the accuracy of the information provided by the third party. Past performance is no guarantee of future results.
This material is from BMO Global Asset Management and is being posted with permission from BMO Global Asset Management. The views expressed in this material are solely those of the author and/or BMO Global Asset Management and IBKR is not endorsing or recommending any investment or trading discussed in the material. This material is not and should not be construed as an offer to sell or the solicitation of an offer to buy any security. To the extent that this material discusses general market activity, industry or sector trends or other broad based economic or political conditions, it should not be construed as research or investment advice. To the extent that it includes references to specific securities, commodities, currencies, or other instruments, those references do not constitute a recommendation to buy, sell or hold such security. This material does not and is not intended to take into account the particular financial conditions, investment objectives or requirements of individual customers. Before acting on this material, you should consider whether it is suitable for your particular circumstances and, as necessary, seek professional advice.