Last month’s $1.9 trillion of helicopter money and now a proposed $2.3 billion pork-barrel, er, “infrastructure” handout to the Biden Administration’s political constituencies have launched inflation expectations into the stratosphere.
The bond market gives us a straightforward measure of how much inflation (using the Consumer Price Index) investors expect. That’s the difference between the yield on an ordinary Treasury note and an inflation-indexed note, or the inflation rate at which investors in the two securities get the same return (or “break-even”):
Breakeven inflation usually tracks the broad commodity price index, but in recent weeks it has soared farther and faster than raw materials prices would indicate.
That’s what happens when you shovel demand into an economy without building productive capacity. Supply chains are straining to keep up all over the world.
As we reported March 20 (“Biden Sleepwalks into Stagflation Nightmare”), input prices to US manufacturers are rising faster than finished goods prices, and at the fastest rate since the 1970s. That portends stagflation.
Delivery times for manufacturers, meanwhile (see the featured chart at the top), are rising around the world as supply chains struggle to keep up with demand.
Ultra-loose monetary policy combined with ultra-loose fiscal policy is a classic foundation for an inflation wave. And the bad news is, there’s no good hedge – not in the short term, in any event.
During the stagflation of the 1970s the only assets that showed positive returns were homes and gold. Home prices are soaring today, but the demographics are different: Home demand was at a peak as the baby boomers reached the age of family formation in the 1970s, but the aging US population requires fewer family homes today.
Gold today trades in lockstep with the yield on inflation-indexed Treasury securities. At some point, the credit quality of the US will deteriorate and gold will decouple, but that could take quite some time, and returns to gold are likely to be disappointing for some time.
The best assets to own are stocks with strong pricing power and low exposure to rising input costs. A good example is US banks, which underperformed the S&P 500 between March and December 2020, but outperformed during 2021 as the yield curve steepened.