Inflation Outlook 2021

After an unprecedented and eventful year, The Golden Investor looks into the future again. Even though the end might be in sight, there is still much economic turmoil to withstand. In this article The Golden Investor tries to qualify the risk for inflation in the near future.

The first thing to note is that real recovery only will happen if there is full group immunity, with the vaccine programs this date seems to come closer and closer. However, it should be noted that until then initial claims are likely to stay at the current elevated level. Boosted by governmental relief programs and support systems, the initial claims are indeed artificially inflated at the moment and a comparison should be taken with a grain of salt. However, the current amount of initial claims are more than three times as high as prior to the pandemic. Ignoring the difference in the spike, as it are completely different shocks, it is visible that the amount of claims in 2010 are, a year after the peak of the shock, only fifty percent higher than before the financial crisis. The Golden Investor argues that the current level of initial claims won’t drop further down until the end of 2021. Along with the Democrat Sweep in the United States more governmental stimulus can be expected over the course of the year. And while lately the FED has kept its policy unchanged, it is still rather vague on what their exit strategy is. However, if there are going to be third and fourth rounds of governmental support, the FED will likely intervene in the Treasury market to keep rates down. The recent revival of precious metals was directly related to this expectation.

Initial Claim
An initial claim is a claim filed by an unemployed individual after a separation from an employer. The claim requests a determination of basic eligibility for the Unemployment Insurance program.
Figure 1 – Initial Claims in the United States during the pandemic
Figure 2 – Initial Claims in the United States during the financial crisis

Strong Consumer Demand Drove Up Food Prices in 2020

It seems almost like a decade ago that supermarkets were raided by shopping thirsty hoarders, a completely economically rational phenomenon, but the surge in demand for consumer products has had its long term effects too. The U.S. Bureau of Labor Statistics calculated that food prices drove up 3.9 percent in the 12-months trailing up to December 2020. A huge inflation rate considering the average rate of 1.6 percent. As the Bureau notes, the drop in energy prices should offset the initial upward effects.

Figure 3 – Consumer Price Index by major categories

Another interesting fact is that the Consumer Price Index for Food and Beverages saw a big surge at the beginning of the pandemic. After initially leveling to a more stable level, now prices start rising again. This could mean that the rise in prices of food and beverages could be a permanent one, therefore indicating the first lasting effects of the extreme governmental spending.

Figure 4 – Consumer Price Index: Food and Beverages

What Are Other Price Levels Saying Us?

However, the main beneficiaries of the lower energy prices are not the workers, rather the intermediaries of between consumers and producers. Especially since drivers are enforced to stay at home, thus not benefiting of the low gas prices. Freight shipping costs should have dropped, but it is generally passed through to end users that order the goods, benefiting clients such as supermarkets, which already were the big winners of the corona crisis. However, taking a look at Figure 5, there is an unseemly strange trend upwards for the Producer Price Index for freight trucking, something that should be cheaper considering the drop in energy prices. The surge in demand for transportation could be one of the reasons for the surge in prices at the end of last year. The significant and sudden rise despite lower energy prices indicates that demand for consumer goods remains strong. However, this rattles up the question what will happen when economies reopen and people get back to work. This could be an indication that inflation may overshoot tremendously, possibly at the end of this year. A first indication of that was visible this week: 10-year Treasuries Bonds yielded for the first time in months above one percent after the Democrat sweep in the United States.

Figure 5 – Producer Price Index: Freight Trucking

A Sleeping Pile Of Money Is Hungry For Yield

Another interesting chart could tell us even more. The amount of cash held in money market funds has risen tremendously over the past three years. This was in a reaction to dropping rates of central banks, even before the corona crisis there were some factors contributing to a more risk adverse investing environment. Lower interest rates enable companies to issue new debt at lower costs, and they happily take advantage of the current ultra-low interest rate environment. This is a particular danger for investors, as 2020 saw the largest issuance of new debt in years, a trend that cannot continue forever. If interest rates would supposedly rise due to the excessive spending and stimulus at the end of the year, an inflationary pressure could put pressure on the central bank to rise rates again. This seesaw problem would be a bitter pill for central banks as more and more companies turn into zombie firms.

Money Market Funds
Money market funds are fixed income mutual funds that invest in debt securities with short maturities and generally hold low risk.
Figure 6 – Money Market Funds

This sleeping pile of money could find its way into markets if the economic turmoil will last longer than expected. However, then again, in such a scenario central banks are likely to respond again, possibly inflating the funds even more. The sleeping pile of money is yet another indicator that financial markets are flooded with money, and it is uncertain if these funds will drive inflation further upwards on the long run. Since the initially deflationary pressure of the lockdowns, the 10-year Breakeven Inflation Rate has risen above the targeted 2 percent level, an indication that inflation may overshoot significantly at the reopening of economies.

Breakeven Inflation Rate
The breakeven inflation rate represents a measure of expected inflation derived from 10-Year Treasury Constant Maturity Securities. The latest value implies what market participants expect inflation to be in the next 10 years, on average.
Figure 7 – 10-Year Breakeven Inflation Rate

Investors should be aware of the massive amounts of newly issued debt in the corona burdened economy. Financial assets make look good right now, but the downward risk is higher than ever now markets are at new highs, while stocks are getting diluted with newly issued shares. A cautious approach with some protection against inflation is advisable. Stock markets tend to be badly affected by rising inflation rates. The recent rise in cryptocurrency prices could be sign of that, however, the price dynamics of cryptocurrencies are not easily explainable. Therefore, The Golden Investor sticks with its precious metals together with copper that create a balance towards changes in economic perspective. Inflation or not, 2021 will yet again prove to become an interesting year for the financial world.

Disclaimer: The Golden Investor is not a fortune-teller, be sure to make the right decisions in accordance to your own financial situation, this is not investment advise or anything like that.



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