Macquarie: MMT consensus not yet here

Via the always excellent Victor Schvets at Macquarie:

We can no longer exit de-facto MMT but not yet ready to accept it

• Does Democratic capture of the senate signal that a ‘blue wave’ has finally arrived? In our view, the answer is Noor at least severely diluted. It should not be forgotten that the Republicans won decisively at a local level (state and gubernatorial) and now control more local levers of power (for redistricting and active or passive resistance) than they did prior to Nov. Similarly, Democratic majority in Congress has been slashed to a ‘razor thin margin’ of only ten members while the Senate is split 50:50, with Democrats risking any piece of legislation, if they lose just one senator. This is a far cry from Obama’s wave when Democrats had 59 senators Clinton’s wave when he had 57 senators.

• There is absolutely no evidence that the new popular consensus has formed. Indeed, as highlighted in our recent notes, the degree of societal polarization has increased, not decreased, and it is now at the highest levels since the late 1960s.The polarization has also by now gone beyond economics to embrace the entire gambit of social, cultural and political issues. Our notes discussed many reasons why polarization has become so extreme, but the key is that it is not diminishing and we believe that there are only two ways out of this tunnel:(a)generational change, but it would most likely take another five-to-ten years; or (b)further significant dislocations (e.g. pandemics, economic, political, geopolitical etc) that would force a faster re-alignment. Assuming that the latter is unlikely in‘21-22, then polarization would become even more intense.

• Why is this important? Without political and popular consensus, it would be hard to implement and sustain meaningful policy shifts. While control of the senate will make it easier for Biden to appoint the cabinet and replace retiring judges and it should allow the Dems to dominate the agenda, most aggressive policies of the true ‘Blue Wave’ will be either abandoned or curtailed. Through filibusters, tiny majorities, resistance from more conservative wing democrats, the need to co-opt some Republicans,inevitable appeals to the most conservative Supreme Court in at least two generations and the forthcoming ‘22 mid-terms, leave limited room for more aggressive policies. For example, there will be no repeal of filibusters, no re-structuring of judicial system, no radical reshape of healthcare policies, no major break-through green deal or infrastructure while taxation changes will likely to be more modest. However, another round of COVID stimulus is on the cards and will be larger (US$600bnplus). Similarly, there will be a more aggressive rollback of trump’s environmental & financial de-regulation and progress on criminal justice & civil reforms. There will be greater international co-operation, but there will be no change to China policy and deglobalization will march on. As the economy recovers, there will be pressure to reduce deficits, from~18% to~6% in‘22. This will continue to place a spotlight on the Fed, as the balancing actor against contractionary fiscal stance. Polarization does not mean bad markets, as long as we stay on the right side of inflation-disinflation pendulum.

• As in the Hotel California we can no longer leave, but we have not yet reached the stage that people want to stay. There is a great deal of difference between temporary and permanent policies, and the US is not yet ready for revolution.

Meaning that:

Inflation debates are heating up. New themes will stay relevant

• Following the Georgia run-off, US 5Y/5Y break-even rates have firmed above the psychologically important 2% cut-off, as investors have started to accept a more robust shift towards fiscal stimuli and, hence, potentially higher inflation. As discussed, we do not view the US election as signalling an electoral shift to the left. On the contrary,it highlighted rising polarization, not consensus, transforming a ‘blue wave’ into something akin to a far more moderate ‘ripple’. Similarly, while no one globally practices austerity, there is equally no desire yet to embark on a permanent expansion of fiscal spending; instead, as we recover from COVID, it is likely that G5 fiscal deficits will be pulled back by~US$3 trillion over‘21-22, leaving CBs to balance vols and risks.

• However, this does not mean that there will be no inflation. Inflation can be caused by underlying economic recoveries, fiscal and monetary policies, and capacity constraints. By now, most investors accept that aggressive use of monetary levers generates disinflation, not inflation (i.e. money printing is not equal to inflation), and most investors also accept that technology and financialization are highly disinflationary. This leaves two sources of any meaningful inflationary pulse: (a) fiscal spending, and in particular the fusion of fiscal and monetary levers and (b) capacity constraints.While we havebeenarguing thatMMT-style policies are the future, we do not believe that,politically or socially, the time for MMT has arrived yet, requiring either further dislocations, five-to ten-year demographic transitions or a mix of the two.This leaves base effect and greater capacity constraints as key inflationary drivers.

• There is no doubt that, mathematically, headline CPI (to a lesser extent, core), will record a significant move into 2H’21. Assuming our energy team is correct and oil prices remain at ~$55/barrel and CRB indices do not significantly exceed 180-200, then G5 (i.e. US, UK, Eurozone, Japan and China) headline CPI could mathematically rise towards 3% plus from 0.5% today, but then inflation is likely to recede to~2% by early 2022. Beyond that point, it will be fiscal policies and constraints that will determine inflationary trajectory. We maintain that fiscal policies will be haphazard and reliance on monetary levers will remain the key, while capacity/input limitations will ease through declining commodity intensity and low cost of capital and technology.As a result, we expect less disinflation rather than a systemic and persistent rise in inflation.

• What does it mean for investors? We continue to believe that the ‘boundaries between sectors and styles are becoming less relevant (i.e. staples are no longer staples, discretionaries are no longer what they used to be, and no one knows anymore what the communications index means). There is also confusion as to what is actually meant by growth, value or quality. Our approach has been to create portfolios that highlight stocks that either play into secular LT themes or corporates that use technology, data and intangibles better (QSG). It is not about social media or tech per se, but rather how one uses them. While themes like alternative energy (EV,etc.)or robotics might be viewed as being in a bubble and might correct, new ways of manufacturing and distributing while reducing waste are the future, which will deliver excess returns and lower inflation.

Readers will know that I would add a turn lower for China to that lowflation outcome for 2022.

David Llewellyn-Smith

Comments are hidden for Membership Subscribers only.