IN THIS ISSUE:
1. Inflation Will Rise & Stock Market Will Correct in 2021
2. Consumer Price Index Exceptionally Low For Last Decade
3. Global Macro Monitor Predicts Inflation Will Jump This Year
4. GMM: Potentially Big Economic Contraction Coming In 2021
Overview – Inflation Will Rise & Stock Market Will Correct in 2021
Earlier this month, one of the leading global economic forecasting groups predicted inflation will rise, potentially significantly, later this year, and the stock market will react very negatively. Global Macro Monitor (GMM), one of the world’s most respected (and most expensive – over $2,000 per year) forecasters made this prediction on January 11.
GMM looked at inflation in over 50 countries and found that prices are already moving higher in almost all of them. Thus, they conclude that the trend in higher inflation is already underway, and they expect this trend to continue as the year unfolds. This, they predict, will lead to higher short-term interest rates, and as I will discuss below, the 10-year Treasury Note yield has already risen significantly.
All this puts the Fed in a difficult position. Fed Chairman Jerome Powell has promised on multiple recent occasions that the central bank is committed to keeping its short-term interest rate near zero indefinitely. We’ll see about that.
GMM believes the higher inflation rate and higher short-term interest rates will negatively affect consumer spending and will likely send the economy into a recession later this year. All of these factors will serve to send the stock markets reeling, GMM warns.
I should point out that most mainstream forecasters are not nearly as gloomy as GMM’s latest predictions. In fact, most economists expect another positive year for GDP. It remains to be seen which group is correct, but I’ll summarize GMM’s latest surprising forecast for you as we go along today.
Consumer Price Index Exceptionally Low For Last Decade
The widely followed Consumer Price Index has been at or below 2.5% for most of the last decade. Over that 10-year period, the CPI averaged 1.7%, well below its historical average and a fraction of what we saw in the 1970s and 1980s. In 2020, the CPI rose just 1.4%.
As I have written often in the past, few of us believe the real inflation rate is remotely at the “official” level represented by the government’s Consumer Price Index. But it is the most widely followed index of inflation.
We all know inflation is going to increase, perhaps significantly, at some point; the question is when. Most forecasters believe inflation will start to rise briskly as soon as we have the COVID-19 pandemic under control and the economy gets back to normal. After all, consumers have significantly cut back on spending during the crisis; the savings rate shot up to record levels in the first half of last year; and thus there is a huge amount of pent-up demand.
Meanwhile, the government and the Fed have flooded the economy with liquidity given the stimulus checks to millions of Americans, with more even larger ones likely to come from the Biden administration just ahead. That’s not to mention the Fed ballooning its balance sheet of Treasuries and mortgage-backed securities from around $1 trillion just a few years ago to something near $7 trillion today.
The point is, the economy is brimming with record amounts of liquidity. The only question is when American consumers will decide to spend it?
Global Macro Monitor Predicts Inflation Will Jump This Year
In one of its reports issued earlier this month, Global Macro Monitor looked at the Purchasing Managers Index (PMI) in over 50 countries. The PMI represents what purchasing managers are paying for the goods they buy to make the products they sell, and thus is a good indicator of inflation.
In its latest survey of PMIs, GMM found that almost all of the 50 countries reported accelerating inflation due to supply shocks last year and higher demand of late. They conclude that while significantly higher consumer price inflation hasn’t shown up yet, it is coming this year. As pointed out above, the CPI rose only 1.4% last year.
GMM believes the CPI will rise above 2% later this year and remain above 2% for the next several years. That may not seem like a lot but keep in mind a rise to 2.1% from 1.4% is an increase of 50%. That should be more than enough to get the markets’ attention; in fact, it already has (see below). And it has gotten the Fed’s attention as well, as I will discuss as we go along today.
Interest Rates Are Spiking, But Stock Markets Don’t Care… Yet
In case you haven’t noticed, the 10-year Treasury Note yield has more than doubled since August, jumping from near 0.50% to 1.10% today. While the Fed says it will hold short-term rates near zero indefinitely, the markets don’t lie.
The Fed’s key interest rate is the Fed Funds rate, which is the interest rate charged to big banks for money they borrow from each other. The Fed’s Open Market Committee (FOMC) controls the Fed Funds rate, which is currently in the range of 0.00% to 0.25%. As noted above, the Fed has promised to keep the rate in that range indefinitely – presumably until the economy recovers from the COVID-19 recession/slowdown.
The Fed has indicated in the past that one of the key interest rates they watch closely is the 10-year Treasury Note shown above. If this is the case, the FOMC has to be very concerned with the action in the 10-year T-Note. This chart is very negative: Not only has the rate more than doubled, it has gapped above the trendline channel – indicating something very different is going on.
GMM believes the spike in the 10-year yield is the direct result of higher inflation expectations around the world. I don’t disagree.
GMM: Potentially Big Economic Contraction/Recession Coming In 2021
Now let’s look at Global Macro Monitor’s specific global forecasts issued on January 11. GMM is a highly respected global forecaster headquartered in Chicago, which is described as “the ‘go to’ source for traders, investors, policymakers and any interested in markets and the global economy.” GMM’s research and forecasts are quite pricey: Their full range of forecasts will set you back over $2,000 a year.
GMM predicts an economic contraction will come in the second half of this year. While they believe the expected stimulus checks of $2,000 per person will keep the economy in relatively good shape in the first half of 2021, they expect a recession to unfold in the second half of this year. They warn this recession could be potentially severe.
Similarly, they expect the recession will affect stock prices negatively. GMM says it would not be surprised to see a stock market correction of 20% or more in the second half of this year. I don’t believe investors are expecting anything remotely that large. With stocks at new record highs, most investors are jubilant right now.
So, if we see a stock market correction of 20% in the second half of this year, and an economic recession, most investors will be shocked. Some will be inclined to dump their stock market positions. What else is new?
At the end of the day, it all depends on how serious the last-half 2021 recession will be. If it is a garden variety recession, only a quarter or two, or something more severe and long-lasting, we’ll just have to see. And that will likely determine how severe the correction in stocks will be.
The bottom line is, GMM expects the economy to remain relatively strong in the first half of this year as the next round of stimulus checks go out. But then in the second half of this year, they expect a potentially global recession to unfold, which could send the stock markets down 20% or more.
Let me remind you again that GMM’s outlook for 2021 is more negative than that of most mainstream forecasters. Most economists are not predicting a recession in the second half of this year. So, we’ll just have to see what happens as this year unfolds.
I have presented GMM’s outlook today only to share with you what one of the most respected analytical firms in the world is currently thinking. I always try to give you a broad range of opinions from the wide range of sources I read each week. We’ll see what happens, as always.
Very best regards,
Gary D. Halbert
© Halbert Wealth Management
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