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Inflation outlook

By Jim Picerno, Director of Analytics

The surge in government spending in recent months to counter the economic blowback from the coronavirus has some investors wondering if monetary and fiscal policies are laying the groundwork for higher inflation. Maybe, although there was no sign of pricing pressure in the May consumer price index (CPI). Headline inflation was negative for a third straight month, cutting the year-over-year trend to a scant 0.1%.

What might change the calculus to the upside in the years ahead? Jim Bianco of Bianco Research (a name reportedly considered as a candidate for a future opening on the Fed’s Federal Open Market Committee) points to monetary policy as tempting macro fate. In an interview with Bloomberg, he cited so-called malinvestment as a possible catalyst.

“As you continue to allow inefficient companies to survive you heighten the chance for inflation,” he reasoned. “You’re going to see an inflation problem that will manifest in 2021 or 2022. That might also bring about higher long-term interest rates.”

The idea of misallocated capital and the economic consequences was originally outlined more than a century ago by the influential Swedish economist Knut Wicksell, who warned that excessively low interest rates (relative to the natural rate of interest) lead to capital misallocation.

If the current policy path is planting the seeds of higher pricing pressure, it won’t be difficult to see the warning signs in the data. With headline CPI currently flirting with deflation for the annual trend, even the slightest whiff of an inflationary rebound will be conspicuous.

Is 2020 a year for active managers?

One of the arguments in favor of actively managed strategies is that humans can spot trouble that’s overlooked in rules-based money management. By that reasoning, this year’s first quarter put the theory to the test as the coronavirus shuttered the global economy and unleashed one of the harshest market corrections on record.

If volatility is the lifeblood for adding value through active management, the evidence to date has been thin, according to research from S&P Dow Jones Indices.

One example: In the domestic equity space, 64% of funds underperformed the S&P Composite 1500 in the first four months of 2020, and 67% underperformed over the past two quarters. Similar results apply for international equities and fixed income.

“Early 2020 results rebut the view that active funds navigate market turmoil better than index-based funds,” reports Berlinda Liu, director of global research and design at the firm. “Mixed results in the short term did not change active funds’ tendency to underperform indices over the long term.”

Has the U.S. coronavirus crisis peaked?

In a word, yes. At least for now.

Indeed, the data make a case for cautious optimism, based on the daily change in Covid-19 fatalities for the U.S. It’s still premature to ring the all-clear bell, but for the moment the numbers look encouraging, based on numbers published by Johns Hopkins University.

Since the April peak, there’s been a clear downside bias. On June 8, the number of deaths totaled 482—a post-peak low, which is well below the 2,500-plus reached at one point in the crisis.

There’s still a huge amount of uncertainty on how the rest of the year and beyond shapes up. In particular, the risk of a second coronavirus wave may be lurking in the autumn and winter. For the moment, however, the trend still looks favorable.

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