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How likely are we to see persistent, higher US inflation?

‘The stuff that’s causing it to spike now is not the stuff that’s going to ultimately cause us long-term structural inflation problems’: Anchor Capital fund manager Peter Little.

SIMON BROWN: I’m chatting now with Peter Little, fund manager at Anchor Capital. Peter, I appreciate the very early morning time. Talking around inflation, you put out a note on the Anchor website last week. There are a couple of points I want to come to. 

The one that really, really struck me is perhaps not core to this point, but it is a sense of who is better at predicting inflation relative to what it is. Consumers – you and I and listeners are very poor at it. The market is not very good at predicting inflation, either. Typically we’re overly pessimistic.

PETER LITTLE: Simon, thanks for having me. The reality is that nobody’s particularly good at predicting inflation – which is not great – but we try our best.

SIMON BROWN: I suppose to the point it is difficult, and hence we’re seeing all the talk around it. Your article in particular was what all that fuss about it is – what are we seeing about it? Your sense? How likely are we to see persistent, higher US inflation? There’s a lot of data in there, but a lot of it and the charts that you put into the article really do support that transitory story.

PETER LITTLE: Certainly the stuff that everybody seems to be worried about, which is causing inflation to spike now, is that there are sort of two baskets that we pick out of that inflation basket that make up about 30% of the total basket. As you say, it’s the other stuff that was heavily discounted to try to attract business during the pandemic that’s obviously seeing prices normalise off that low base. Obviously, that can’t carry on forever. Once that stuff’s in the basis, that’ll weigh in. 

And then the other basket is the goods that are seeing supply bottlenecks, particularly stuff linked to the computer-chip segments, vehicles in particular. They’ll figure out a way to sort out those bottlenecks; it’ll probably take a few months. But again, that stuff we think will be transitory. We are not saying that you don’t necessarily have to worry about inflation, we’re just saying that the stuff that’s causing it to spike now is not the stuff that’s going to ultimately cause us long-term structural inflation problems.

SIMON BROWN: And that structure that is the issue then brings us to the likelihood of meaningful higher rates in yields. You make a great point that US households, the US financial sector, and the US government went into the Covid crisis significantly better off than in the 2008 global financial crisis. It was just (a case of) better balance sheets, a healthier financial space, and economy, which means the coming out and hence the worries around structural inflation and higher yields are muted.

PETER LITTLE: Certainly for consumers and corporates the balance-sheet worries are not really there because the US government basically took all the pain during the pandemic. It increased its debt fairly substantially in lieu of basically the man on the street and the companies having to do that. So yes, that’s helped a lot. The higher rates won’t put as much pressure on the private sector coming out of this.

SIMON BROWN: And then the concern – there are two issues. One is rate increases. The more immediate issue perhaps is that tapering and a potential taper tantrum. We certainly saw a fairly significant one in 2013 when the Fed tried to taper down and reduce spend. You’re saying actually hang on a second, we’re way better off than in 2013. The rate of QE (quantitative easing) is larger, but actually a smaller portion of new issuances. And that taper tantrum – we might see one, but it will probably be smaller and less tantrum-y.

PETER LITTLE: We look at the difference, for a start. The difference this time is we’ve been through a taper before; we sort of know what to expect, so it’s not completely wandering into the dark here. But just because the size of the balance sheet has increased and also the size of the US corporate, the US government issuance has just increased so much we’re only seeing the government take up about 7% of the of the issuance every month. I think in the previous crisis it was about 15% of the issuance. So when they step away there’s a much smaller hole for the rest of the market to kind of pick up the slack this time. So we think that’s pretty helpful.

We’ve seen rates back up in anticipation of this taper happening now, whereas the previous time markets were slightly more sanguine about what might happen; they had further to fall, or further to rise when the taper actually started happening. 

So we think those things are helpful this time. We know what’s happening, there’s a smaller hole being left by the Fed stepping away, and rates have already backed up a little bit. So we think that will make the taper impact ultimately slightly less aggressive than it was last time.

SIMON BROWN: I liked that point that we’ve actually been down this road before. It does give us a little more experience. The conclusion then which you draw is that in essence, we will see rates go higher. They’re unlikely to move significantly, but they are still well below, I want to say, normal rates perhaps – although I don’t know what normal is these days – and hence the impact to the stock market, the fear out there, is perhaps unwarranted.

PETER LITTLE: We think that 10-year rates will back up towards 2% over the next 12 months. They’ve still got a way to sell off from here but in the greater context of things that’s not particularly attractive if we think inflation’s around 2% probably – still negative real rates. So not particularly exciting. We think the stock market is still much more attractive on a relative basis, and the search for yield is not going away just because we’ve got 2% government bond rates. Even though that’s higher than now, it’s not attractive.

SIMON BROWN: You point out that in the nineties cash was 5.2%. In the 2000s the 10-year was 4.2%; 2% is not thrillingly exciting there.

Peter Little, fund manager at Anchor Capital. I appreciate the early morning time.

Listen to Monday’s full MoneywebNOW podcast here.

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