Expect "subdued" inflation in 2021, although a "modest" year-over-year increase will appear in the spring since it will be measured against a shut-down economy from last March and April, according to the Payden & Rygel economics team.
“Inflation looks subdued across the world, whether you look at the U.S., Europe, or China," the group said in a report. "Apart from a modest pick up in inflation in the spring due to 'base effects' (easy comparisons to the shutdown induced readings from last March/April), inflation will remain subdued worldwide in 2021.”
The past decade showed that inflation was in check despite a 3.5% unemployment rate, soaring central bank balance sheets and higher debt-to-GDP levels.
"Central banks will be disappointed by low inflation," according to the report. "The Fed has been missing its inflation target consistently since 2012." And while they will try to “make up” for misses to the downside over the past decade, "trying is not the same as engineering higher inflation," the authors say. “The global nature of low inflation tells us the outcome may prove to be beyond central bank control, at least in the short run.”
Further, the Fed’s revised framework that uses inflation averaging, means higher inflation alone won't translate into rate hikes.
“The bottom line is that extraordinarily easy monetary policy is here to stay,” the report concludes. “And the Fed’s stance will put other global central banks in a tough spot. After exhausting other monetary policy tools already, continued balance sheet expansion seems likely for the European Central Bank, the Bank of England and Bank of Japan in 2021.”
Brian Rehling, head of global fixed income strategy at Wells Fargo Investment Institute, pointed out that with the January rotation of voters the Federal Open Market Committee will lose both a hawk (Federal Reserve Bank of Cleveland President Loretta Mester) and a dove (Federal Reserve Bank of Minneapolis President Neel Kashkari), who will be replaced by centrists.
With a more centrist panel, and a president expected to respect the central bank's independence, he said, cuts policy risk going forward.
But, Rehling added, the Fed still has “a lot of work to do” to meet its dual mandate.
“The Fed stands ready to provide additional monetary support if needed; absent any significant market dislocations, we expect the Fed to continue its current course of bond buying and low rates,” he said. “We look for short-term rates to remain anchored and do not expect the Fed to consider negative rate policy. We could see the Fed focus its bond buying on longer maturities in the year ahead to limit the risk of higher long-term rates.”
The global macro strategist team at Morgan Stanley suggests, while possible, "a large compression of U.S. interest rate volatility," would be a surprise, but wouldn't "necessarily result in a decline in U.S. interest rates."
The report, with lead author Matthew Hornbach, says, "It is plausible — although not likely — that further anchoring of rate expectations ... could suppress rate expectations volatility, and offset the rise in term premiums."
Payden & Rygel sees "a lengthy and highly uneven recovery, due to lingering effects of the virus, permanent damage to the economy, and lack of additional stimulus.”
And while the virus still creates risk, the vaccine should be widely available by the second quarter of 2021, they said. The recovery, which they see as V-shaped to this point, "progressed much faster than anyone expected just a few months ago." But not all sectors have seen similar gains, "That’s where the 'unevenness' comes in."
Because the virus has determined how the economy progressed, or regressed, "good news on the virus front will propel the economy forward in 2021," with the service sector joining the "goods" rebound, as pent up demand is released.
Scott Wren, senior global market strategist at Wells Fargo Investment Institute, believes the stimulus package “should provide a temporary patch that will allow the economy to grow modestly until the vaccines are more widely distributed.”
“In our opinion, this additional stimulus was necessary to help consumers get through the current rough patch and boost spending until the COVID-19 vaccines are more widely distributed and more people are vaccinated,” he said. “This is likely to take some time, but a number of estimates suggest mid-year 2021 as the time frame."
