open pdf version“Informed decision-making comes from a long tradition of guessing and then blaming others for inadequate results.” – Scott Adams

In these still early and unprecedent days, forecasting the near-term social and economic impact of the pandemic feels like a tall order; attempting to look out one year or beyond feels like a Magic 8-Ball consultation:

Will we have more answers than questions in 2021? “Cannot predict now.” Will economic growth rebound in 2021? “Ask again later.” Will the price of goods and services be higher or lower in 2021? “Yes – definitely.”

This last question, which focuses on inflation, is a recurring theme as central banks pump trillions of dollars into our financial systems, governments borrow trillions of dollars to put a floor under their economies, and consumers confront flour, egg, and toilet paper shortages at grocery stores everywhere. If that doesn’t sound inflationary, I don’t know what does. Of course, economic answers are full of assumptions and conveniently ignore unknowns, so inflation is not a foregone conclusion. As I will argue here, the more likely outcome of the pandemic is deflationary (or, at least, disinflationary) ‒ not inflationary.

In the context of modeling the economic impact from a global pandemic, there is one thing we know for certain. The level of herd immunity regionally, nationally or globally will be key to the pace at which our societies and economies re-open and recover. Magic 8-Ball, do we know the level of herd immunity today? “My sources say no.” As does my colleague Jeff Elliot in his recent blog. This leaves many question marks around the ultimate depth and length of the economic recessions and strength and timing of the recoveries.

At the very least, we can learn from China, South Korea and other places that were hit before North America, and where new, small outbreaks have occurred in later stages of re-opening. We should expect similar setbacks here at home, yet, once again, the severity and timing of those setbacks remains uncertain. To us, all these knowns and unknowns imply that consumption behaviours and business operations will take much longer to return to pre-COVID-19 levels than many people think or hope. The longer it takes for societies to normalize, the more likely it is that we will experience deflation. Despite the seemingly never-ending responses from our policymakers, it is important to look at the impact of the fiscal response on aggregate demand, the monetary response on the movement of money in the real economy, and the change in unemployment on propensity to consume.

Fiscal support is not fiscal stimulus

The staggering government fiscal spending packages we have seen to date have attempted to bridge income gaps. At best this has helped to minimize the drop in aggregate demand as economies shut down, but ultimately, aggregate demand has fallen. This is a deflationary shock as Ben Bernanke, former chair of the U.S. Federal Reserve (Fed) reminds us: “The sources of deflation are not a mystery. Deflation is in almost all cases a side effect of a collapse of aggregate demand…a drop in spending so severe that producers must cut prices on an ongoing basis in order to find buyers.”

Economic theory tells us that government spending can be expansionary (and, thus, possibly inflationary) when there is a large, positive multiplier effect; that is, the government’s spending generates spending in other segments of the economy resulting in an aggregate increase in demand for goods and services. While it is possible that governments will consider additional fiscal packages to stimulate their economies, they will likely wait for their economies to be sustainably re-opened. To us, this means that we will first need a vaccine.

More money, moving slowly

Drawing again on economic theory, expansionary monetary policy – such as cutting interest rates or increasing the money supply – can result in inflation if it increases aggregate demand. In response to the COVID-19 pandemic, central banks have cut interest rates and/or launched new quantitative easing (QE) programs to increase the money supply in our financial systems. However, due to bank regulations, the increase of the money supply in the real economy has been considerably smaller. Furthermore, an increase in the supply of something does not mean an increase in the demand for something. This is why the concept of “velocity of money” is so important when we talk about central banks printing money. The velocity of money tracks how many times money exchanges hands; the greater the number of transactions, the more likely we are to see inflation. Despite numerous QE programs over the past decade, the velocity of money has continued to fall (see Figure 1 below) – a trend that is likely to continue as economies have ground to a halt. This will continue to exert downward pressure on inflation in the years to come.

Figure 1: Persistent drop in the velocity of money

persistent drop in the velocity of money
Source: Bloomberg Finance L.P. as at December 31, 2019.

Lower income earners have seen most unemployment

The economic shutdowns have impacted all sectors, but services have been among the most vulnerable – things like leisure and hospitality, accommodation and food services, and retail trade. These sectors, whose workers are generally younger and earn lower incomes than average, have had less flexibility in moving their operations online and have seen the greatest increases in unemployment or furloughs. Interestingly, however, national wage growth rates have risen alongside recent unprecedented increases in unemployment rates. This inconsistency reinforces the fact that lower income earners (which also tend to be younger workers) have disproportionately lost their jobs and/or incomes; a development also supported by a recent Pew Research Center poll (Figure 2 below.)

Unfortunately for aggregate demand, young and lower-income workers have the highest propensity to consume, suggesting a larger-than-expected negative shock. Furthermore, we see signs that these vulnerable sectors will face obstacles in returning to full operating capacity for the foreseeable future, thus postponing a recovery in employment and a full recovery in aggregate demand, which undoubtedly is a disinflationary outcome.

Figure 2: Lower income earners, younger people have lost their jobs and/or incomes

About 3 in 10 Americans have lost a job or taken a pay cut due to COVID-19
Source: Pew Research Center

Risks to outlook: possible sources of inflation in the medium term

Countries can enact policies to devalue their currencies to import inflation. However, for an advanced economy, this is extremely difficult to do when your peers are using the same fiscal and monetary policies. As mentioned earlier, we can also see inflation if governments pursue effective fiscal stimulus spending programs once economic recoveries are fully underway. Finally, global geopolitical tensions – particularly between U.S. and China – continue to intensify. There is a real possibility that we will have two clearly defined spheres of influence in the medium-to-long term (beyond five years), whereby global business supply chains will no longer have access to the low-cost efficiencies that have benefited them over the past several decades. This could increase business costs and generate supply side inflation. However, these concerns will not affect our deflationary view for the next two years.

“If inflation is the genie, then deflation is the ogre that must be fought decisively.” – Christine Lagarde, President of the European Central Bank

Magic 8-Ball, will interest rates rise in 2021? “Don’t count on it.” The clearest implication of our deflationary view is that interest rates are not rising in the coming years. The Fed and other central banks have told us repeatedly that generating sustained inflation will drive their decision-making frameworks. If negative output gaps remain (that is, economies are operating below their potential), deflationary (or disinflationary) pressures will prevail. Thus, central banks are expected to maintain record low interest rates and will seriously consider or adopt far more aggressive easing policies (such as negative interest rates, yield curve control, and helicopter money) until output gaps close and inflation is sustainably around 2%. Consequently, the challenge for investors will be two-fold: record low interest rates, coupled with suppressed interest rate volatility that will undermine traditional portfolio diversification and construction principles. But more on this another time.

Our baseline estimates suggest it could take almost three years to close output gaps in North America. Unfortunately, it means that our advisor partners and their clients will not get income in traditional fixed-income solutions that are centered around domestic, risk-free government bonds. They will need to assume more risk by turning to Signature’s investment solutions that have greater income-generating potential from higher exposure to credit spreads and real assets as alternatives to their traditional fixed-income holdings. That is the reality of our deflationary world.

Income Opportunities
within Signature
Morningstar Rating Overall
Fixed Income Sentry Global Investment Grade Private Pool Class Global Fixed Income ★★★★★
Signature Corporate Bond Fund High Yield Fixed Income ★★★★
Signature Preferred Share Fund Preferred Share Fixed Income ★★★★
Diversified Income Signature High Income Global Neutral Balanced ★★
Real Assets Signature Global REIT Real Estate Equity ★★★★
Signature Global Infrastructure Global Infrastructure ★★★★★

Source: Morningstar Research Inc., as of April 30, 2020. This fund list represents only a selection of investment strategies at Signature. Please refer to your financial advisor or the CI Sales Team for further information on these and other Signature funds.


Sources:  Bloomberg Finance L.P., Pew Research Center, Morningstar Research Inc. and Signature Global Asset Management.



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Published May 28, 2020.