Dan Fuss, vice chairman of Loomis Sayles and one of the world’s best-known bond investors, will be the first to tell you he is confused about the markets. But count him in the camp that doubts the U.S. economy is headed for a V-shaped recovery.
He is confident, however, that the long-term outlook includes a resurgence of 1970s-style inflation.
Fuss, who spoke Tuesday during a webcast hosted by the Boston chapter of the Professional Risk Managers’ International Association (PRMIA), was joined by Lisa Emsbo-Mattingly, an economist who is director of research, global asset allocation, for Fidelity Investments.
“The one thing I do know,” said Fuss, “is from just looking at what the analysts are saying, and in particular, talking to some of the loan analysts: Credit fundamentals are not good in a fairly broad area. Hopefully this recovery will be a ‘V,’ but it looks to me more like the possibility it is going to be a couple of Ws hooked together with a slightly upward slope.”
Fuss said the closest historical analogy to what is happening was more than 60 years ago. During 1957, the U.S. slipped into a recession, was recovering by the end of 1958, and then was back in a recession in 1960. “I think that was all one downturn,” Fuss said. “It just started to ripple through. It never felt like there was this magnificent recovery. I was out in the business world trying to make a living, and to me, it was 1963 before you could really see that things were moving again.”
Emsbo-Mattingly also questioned prevailing Wall Street sentiment. “The markets have basically priced in a V-shaped recovery at this point. … they’re implying that everything is in the rearview mirror and everything is going to go just swimmingly going forward. … I’m a little bit skeptical of the Happy Days Are Here Again narrative that the markets are telling us at this point.”
Next year, she said, the economic picture may not be any clearer. The U.S. is running about a 19% fiscal deficit this year and she’s seen estimates that in 2021 the deficit will be in the 9% range. “That’s actually a fiscal tightening. It may be a recovering economy, but I think 2021 might be just as confusing as 2020 has been.”
The approach of the U.S. government and the Federal Reserve to fiscal and monetary policy next year will be affected by many factors. Among them are who wins the U.S. presidential election in November, how the COVID-19 crisis plays out and whether U.S.-China relations continue to deteriorate, Fuss and Emsbo-Mattingly agreed.
Emsbo-Mattingly showed the following chart outlining rising policy and political risks:
Neither Fuss nor Emsbo-Mattingly expect negative real interest rates to disappear anytime soon. In addition to geopolitical issues and the pandemic, Fuss believes civil unrest is a shorter-term risk and climate change is a longer-term one that also are creating instability and are concerns for policymakers.
On a positive note, the money the Fed is injecting into the economy as a result of the pandemic has provided an offset to income loss for millions who suddenly found themselves unemployed. “It’s a really outsized response from the central bank, and certainly seems warranted given the dramatic declines in employment and economic activity,” Emsbo-Mattingly added.
But rising debt brought on by massive government spending raises a lot of big questions, and one of those is whether it will lead to inflation. Global debt as a share of GDP is at “almost incomprehensible levels, and this is long before COVID hit. And many people argue that the only way you can deal with that amount of debt is with inflation,” Emsbo-Mattingly said. At the same time, she noted, other impacts could create deflationary pressures.
But she and Fuss agreed inflation is most likely coming. They just don’t know when.
Fuss believes when inflation does arrive in the U.S., it will feel similar to the inflationary experience in this country during the late 1960s and 1970s. “I think it’s going to get out of hand. So the question then becomes, how can an individual central bank, in this case the U.S., control it? When the Volcker regime came in to snuff out inflation [in the 1980s], I doubt we can do that again. I think it’s going to have to be a different thing.”
Fuss added inflation may not be the biggest problem facing the United States. “I do think inflation is coming; I just don’t think we’re going to see it near at hand, and if this U.S. and China thing doesn’t get resolved, it will be irrelevant.”
Dorothy Hinchcliff is editor of Advisor Perspectives.
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