Expert view: Will the policy response to COVID-19 bring dormant inflationary forces alive?
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For central banks and governments in the modern economy, no one has ever had to formulate a response to a global health pandemic before.
And in the wake of those unprecedented support measures, a number of big names in the financial community are questioning what the fallout will be.
Among the many views, some have questioned whether it will give rise to a mysterious economic trend that’s been missing in action for more than 10 years — inflation.
For example, billionaire Charlie Munger (Warren Buffett’s right-hand man) recently told the WSJ that government support should help prevent the COVID-19 recession from turning into a depression. Although he added that “we may have a different kind of a mess. All this money-printing may start bothering us”.
Another US billionaire, hedge fund manager Paul Tudor Jones, turned heads with the announcement that he’d allocated some capital to Bitcoin, as a hedge against possible inflation in the wake of the COVID-19 policy response.
To get an expert’s view on the outlook, Stockhead caught up this week with Alex Joiner, chief economist at global fund manager IFM Investors.
Turning to the Australian market, Joiner said it was hard to see how the response efforts from the Morrison government and the RBA would translate into rising inflation anytime soon.
For starters, he noted that since Australia last had a bout of deflation in early 2016, the RBA had adopted increasingly supportive policy settings in an effort to get inflation moving back towards its target range — to no avail.
And in the wake of COVID-19, Joiner said the fiscal and monetary responses in place were “just supporting the economy, they’re not really stimulating it aggressively”.
“I think from a demand perspective, the question is — where are these (inflationary) pressures going to come from?” Joiner said.
“There’s no doubt central bank policy is asset-price inflationary, but to my mind it’s not having the desired effect to get inflation back to target (2-3 per cent) growth.”
“It might be supporting it, but in the near-term Australia is going to be in a deflationary environment. And we’ll see that in the June quarter because of the things we know are happening.”
Inflation is a complex beast to calculate, and Joiner highlighted that Australia’s CPI basket was made up of no less than 87 different categories.
Analysing some of the key components, Joiner said the introduction of free child care as part of the corona response would have a material impact (in reducing inflation).
He also noted the effect of lower petrol prices following the oil price slump, the postponement of annual hikes in private health fees and slower activity in the housing market (which comprises 17 per cent of the basket).
“Most people will be looking for a negative (deflationary) quarter in Q2, and that typically flows through to a weak inflationary environment,” Joiner said.
Looking ahead though, will the outlook change in the second half of the year as the health crisis recedes and economic activity picks up?
Joiner said that despite talk of “snap-backs” or a V-shaped recovery, in reality the recovery was likely to be more gradual.
While equity markets have recovered a chunk of their March losses (for now), stocks are still off their pre-COVID highs, while the property market is looking more subdued.
“I don’t think we’re going to overshoot where everyone just gets out there and places are crowded,” Joiner said.
“People tend to save when their wealth has been challenged like this, and that creates a pretty cautious environment for the consumer unless there’s sales & discounts.”
However, “discounting is disinflationary too. We might see a bit of supply chain impact working in the opposite direction, but unfortunately — for retailers in particular — they might just have to incorporate that into their margins”.
Increasingly tighter margins are a fact of life for Australia’s embattled retail sector, which makes up the biggest component of the inflation basket at around 30 per cent.
Joiner said a good example was when the Australian dollar fell from above parity with the USD in 2013 back towards US70c. In the absence of a sophisticated currency hedge strategy, many import-reliant retailers were forced to wear that cost, rather than pass it onto the consumer.
“It’s something we’ve seen the last five or six years, where they just haven’t been able to pass it through. And if you look at the (post-COVID) retail numbers and work out the deflators, prices fell everywhere except food,” Joiner said.
So having analysed the components of the CPI basket, we can see the prospect of a near-term inflation fright is unlikely.
However, the aggressive support measures implemented in the wake of COVID-19 are in some ways an extension of structural challenges that existed beforehand.
“There’s a huge amount of money in circulation, but none of it’s moving through the real economy — it’s moving through asset markets,” Joiner said.
“We’re in a situation where Q2 US GDP will collapse with unemployment rising to 15-20 per cent, and based on current valuations equity markets are happy with that — something’s amiss.”
It brings to mind the old adage of “never bet against central banks”, Joiner said. But he added that last time the US central bank extended its tapering of asset purchases (in 2018), equity market returns were “pretty poor”.
“So it raises the familiar question of ‘how are central banks ever going to wind back this largesse’?”
In the meantime, Joiner said it’s unlikely Australia’s economy will come roaring back into 2021.
“Say the economy contracts 10 per cent, the snap back aspect will be 5 per cent, and that remaining 5 per cent will come back over the course of years,” he explained.
“We’ll get back to where we were, but it’s not going to happen in a quarter or two. It will take an extended period of time.”