Tim Hext: Budget deficits are now structural and inflation will be back

Portfolio manager Timothy Hext from Pendal's Bond, Income and Defensive Strategies team.

The next five years will see inflation significantly higher than the past decade. We should be alert to this but not alarmed says Pendal portfolio manager Tim Hext in our weekly Bond, Income and Defensive Strategies note.

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THE two big highlights of the week were the federal budget and US inflation numbers — and they are more closely linked than it might seem.

Federal Budget

The RBA and Treasury now forecast GDP and employment at full capacity for next year.

That means no slack left in the economy. Normally this would signal a tightening of monetary and fiscal policy. But times have changed.

Invoking the continuing transition from the crisis, the RBA and government are both firmly foot-to-the-floor.

For the government a looming federal election translates to “why not keep handing money out?” After all no one seems too troubled.

Even the usual crowd of economists who warn of impending doom from too much debt have gone quiet. The only ones who can hold their heads high are proponents of Modern Monetary Theory. They understand better just how government debt works.

The RBA seems to have gotten itself in a corner. Like the rest of us they expected the health crisis to be far worse. Unlike us they made commitments (or guidance in some cases) out to 2024 based on that expectation.

The RBA is more oil tanker than speedboat when it comes to turning around. For now they remain committed to Quantitative Easing, Yield Curve Control and no rate hikes.

This is now based solely on benign inflation and wage forecasts — not growth and employment, which are strong.
Future RBA statements will be watched closely for watering down of rhetoric.

US inflation

That leads us to this week’s US CPI numbers. CPI was 0.8% for April and 4.2% year-on-year.

Extraordinary numbers.

Economists and no doubt the Federal Reserve will be quick to reassure us this is transitory.
Pendal named 2020 Fund Manager of the Year in Zenith Awards.
Supply bottlenecks in the auto industry have prompted a spike in used car and rental car prices. Hotel rooms, airfares, sporting events — most things have spiked as the economy reopens.

These spikes won’t repeat but other spikes are coming. Rents are creeping up and wages are already rising. Commodity prices are taking off.

If there is excess capacity in labour markets perhaps the Fed can get away with the idea of ignoring these transitory factors and we can return to business-as-usual low inflation.

I suspect though with ongoing massive fiscal and monetary stimulus the inflation genie is out of the bottle.

Low inflation expectations may become, if not unhinged, at least challenged in the years ahead. Wages could well follow. Inflation in Australia will also follow.

Eventually technology and demographics will keep a lid on inflation becoming a massive problem.

But the next five years will see inflation significantly higher than the last 10 — something we should all be alert but not alarmed at.

Tim Hext is a portfolio manager with Pendal’s Bond, Income and Defensive Strategies (BIDS) team.

Led by Vimal Gor, Pendal’s BIDS boutique is one of the most experienced and well-regarded fixed income teams in Australia. In 2020 the team won the Australian Fixed Interest category in the Zenith awards.

The team oversees $22 billion invested across income, composite, pure alpha, global and Australian government strategies with the goal of building Australia’s most defensive line of funds.

Find out more about Pendal’s fixed interest strategies here


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