Three things to watch in 2021.
As we look for a globally synchronized recovery in the year ahead, we’ll be watching:
- Modern Monetary Theory Once just a theory, MMT is in practice, if not yet in name (cornerstones require permanent zero interest rates and job guarantees), with trillion-dollar deficits as far as the eye can see and unprecedented monetary stimulus on top of unprecedented fiscal stimulus. If Dems take both U.S. Senate seats in the Georgia runoffs, a $2.2-3.5 trillion package of additional aid is possible and could grow larger with an infrastructure component (not to mention, the Green New Deal). The Fed has formally committed to keeping policy “accommodative” until its 2% inflation overshoot has been delivered. Since accommodation leads inflation, the Fed is accepting it will overshoot its preferred overshoot. At December’s meeting, policymakers signaled tapering isn’t on the table and larger quantitative-easing purchases are possible. Vice Chair Quarles recently suggested the growing size and sheer volume of the Treasury market begs the question on whether there’s “an indefinite need for the Fed to participate as a purchaser to support market functioning.” We are in unchartered territory.
- Maybe deflation is the bigger worry Wall Street consensus sees prices picking up next year—the percentage of clients worried about inflation over the next three years hit a record 77% in Strategas Research’s December survey. This view arguably ignores a digitization surge that saw a 20-year rise in tech equipment/software spending kick into high gear this year, with Q3 tech equipment capex up 13% year-over-year. This suggests productivity growth, which broke out of the doldrums in 2020, could continue to run, countering any pricing pressures. Both the decimation of unions and the rise of globalization over the past several decades have erected huge structural impediments to inflation, as has the fact that money supply growth has flowed more into corporations and equity markets than into the hands of consumers whose spending ultimately leads to supply constraints. Indeed, capacity utilization remains nearly 5% below its February level and well below long-term trends. While never in history has there been such rapid money growth without a major inflation shock, SIS Research says never have there been so many headwinds in place to mitigate inflation risk. Icing on the cake—historically, an aging society coupled with ever-increasing government debt is a formula for deflation, not inflation.
- My eyes will be keenly focused on the dollar With MMT already seeming to work so well (witness a record stock market and V-shaped economic reports), a possible Democratic sweep (spending trillions more??) and a Fed willing to live with inflation above its 2% target for some time, the dollar will tell us how the world sees our largesse. These grand experiments in fiscal and monetary policy raise the long-term stakes for the greenback and its concomitant impact on inflation, interest rates and the prices of hard assets. Ultimately, the dollar may be bailed out because the U.S. is not alone in its "whatever it takes" approach to combating Covid’s economic devastation. Still, one would presume that, sooner or later, there will be limits. The dollar has been weakening without much notice this year, but broached key resistance barriers in mid-December vs. the euro, British pound and Aussie dollar. This slippage already shows signs of easing global deflationary pressures that have been in place since late 2018. And with its textbook impact on domestic inflation proving more theoretical than real so far, the weakening dollar tends to be bullish for stocks, as do low rates and restrained inflation. The best of all worlds—so far.