Whilst the potential for inflation has been on the rise recently, we still feel it’s unlikely that we’ll see any undesired increase in price levels at least for the next year. With inflation risks out of the way, the narrative for fiscal stimulus will drive the reflation case. With that, it’s important to identify the type of reflation we’re expecting. Do we expect reflation to be driven by global economic growth, or by “lower quality” drivers such as fiscal spending and weaker USD? Whilst the impact on asset prices might be similar (higher Emerging Markets and Commodities), the latter narrative is weaker and should make market participants more cautious about their “return to normality” expectations.

In the last Macro print, we concluded that, given the current levels of stimulus, Austerity measures won’t be enough to cover the bill. Extreme fiscal spending financed by unconventional measures (such as Modern Monetary Theory) is in vogue and a key proposition for the post-Covid world. For this to materialize, we’ll likely need to move to a more centrally planned economy, and history has not voted in favor of this kind of regimes. Unfortunately, whilst the most common argument against MMT refers to the risks of growing inflation (which we share), we believe that the larger risk to consider is the increased size of the government’s share in the economy, which is likely to lead to the misallocation of capital and, to a larger extend, a less productive economy overall.

Given the recent $20 trillion of stimulus sponsored by governments and Central Banks all over the world to keep the global economy afloat amidst the COVID pandemic, we asked ourselves who and especially how are we going to pay for this spending regime. Austerity measures, which target a decrease in government spending and an increase in taxation, are unlikely to be enough to cover the current level of spending.

Many global data points appear to be carving out a V-shaped recovery. This is deeply misleading, merely reflecting the depth of the economic decline, rather than the success of the rebound. Leaders are already preparing to add yet more stimulus.

Decades-long loose central bank policy has led to many unintended consequences, most acute as of recent however, is the increase in zombie firms that are unable to service their debt loads with current and forecasted cash flows, as well as the growing chasm of wealth inequality being blown wide open. The capitalist construct that drove wealth creation over the past few decades now resembles more of a wealth transfer mechanism via asset price inflation, than a wealth creation one.

Inflation and deflation, the stuff of Econ 101, has become a tribal debate among financial markets participants. We believe that, despite monumental monetary and fiscal stimulus from central banks and governments, we’re more likely to see deflation than inflation in the short to medium term (unfortunately).