When focusing on subsequent developments in terms of long-term interest rates, it is important to distinguish between the US and the rest of the world. This is because US vaccination programmes are running far more smoothly, and the US is implementing by far the most fiscal stimulus. This is bound to culminate in more economic growth and more upward pressure on inflation compared to other economies in the world (perhaps with the exception of the UK). So, if long-term interest rates rise further, this will initially be evident in the US. Nevertheless, many other countries – especially those in Europe – are increasingly moving towards more fiscal stimulus, and they will probably soon begin to catch up with their vaccinations.
Strikingly, US policy makers are placing far more emphasis on the high unemployment rate and the considerable overcapacity at this point. Both factors are the main reasons why higher structural inflation is generally not anticipated for the time being. However, it is very difficult to measure the level of unemployment and capacity utilisation. So far, many theatres, restaurants, bars, and so on, have been kept afloat with government support and are therefore included on the supply side. However, this government support will largely disappear once the lockdowns are lifted. In this case, a significant number of companies in vulnerable sectors will disappear after all. The supply of goods and services will decline in this case, while the demand side will remain stable due to fiscal stimulus and the spending of accumulated savings. In addition, commodity prices are likely to stay under upward pressure once the global economy picks up. It is also striking that more and more companies are unable to recruit well-qualified staff at this point. This is evident in a climate in which there is a surplus of money and credit supply is gaining momentum.
In view of the above, we believe that events in the US will go beyond just a temporary rise in inflation. This will subsequently also apply to the rest of the world.
Chart 1: After lockdowns are lifted, government support will decrease leading to more bankruptcies
Source: Refinitiv Datastream/ECR Research
Too little, too late?
However, we wish to go one step further. At any rate, the Fed has stated that it only wants to take proper action once wage increases and inflation have risen to distinctly higher levels. The latter depends on developments in terms of unemployment and capacity utilisation. If we look at the relevant forecasts – which are too conservative in our view – the general expectation is that there will be full employment and capacity utilisation by late 2022/early 2023. From that point onwards, wage increases and inflation will be under upward pressure.
However, changes in monetary policy will only have an impact on inflation with a delay of roughly four quarters. If the Fed, in turn, says that it only wants to take action if inflation shoots up to above 2.5% – measured by the CPI – this means that an inflation rate of 3% or higher will have to be anticipated for a long time to come. It subsequently remains to be seen whether the Fed will really reduce inflation. Importantly, the US is also faced with a massive debt pile.
In addition, economic growth will have to go back to potential growth once the point of full employment and capacity utilisation has been reached. This serves to prevent all manner of major imbalances. Potential growth is the sum of productivity growth and the increase in the workforce. Potential growth will continue to hover close to 2% for the time being, in spite of recent positive reports about higher productivity growth over the next couple of years. Therefore, if the Fed is going to counter inflation, we will have a prolonged period during which growth ends up below 2%, debts end up at ever higher levels and real interest rates rise. This combination could soon cause the debt mountain to become unstable and therefore trigger a new credit crunch. It would barely be possible to absorb the impact of this crisis, as the scope for monetary and fiscal stimulus would still be limited in this case.
Chart 2: Combination of low potential growth, rising real rates and lower inflation rates could lead to credit crisis
Source: Refinitiv Datastream/ECR Research