Joseph V. Amato, President and Chief Investment Officer—Equities

February 22, 2021

The latest 10-year outlook from the Congressional Budget Office offers comfort to those who don’t want to worry about the fuel bill. The forecast average deficit looks big but manageable by today’s standards, particularly with rates where they are. Inflation is forecast to rise gradually, averaging just 2.1% later in the decade, with the 10-year Treasury yield rising sedately to 3.4% by 2031.

That aligns with what central bankers are saying. Last week, Federal Reserve Chair Jerome Powell again downplayed the inflationary potential of the stimulus proposals. In Europe, after the Bundesbank president warned of a surge in Germany’s prices, the European Central Bank’s Christine Lagarde was quick to note that Eurozone inflation is expected to remain below target for several years.

But skeptical voices are rising—and not always from the usual suspects. Former Treasury Secretary Lawrence Summers, who worked in both the Clinton and Obama administrations and was a noted fiscal dove in the aftermath of the Global Financial Crisis, has warned that the coming stimulus threatens “inflationary pressures of a kind we have not seen in a generation.”

Our own view is that inflation will pick up—as seems inevitable given the growth outlook, policy support and the weak inflation numbers from last spring—but that fears of problematic inflation (sustained levels in the 3 – 4% range and beyond) are unwarranted.

Markets, however, may be having second thoughts.

In equity markets, things are calmer, at least on the surface. That likely reflects the soothing words from the Fed. But soothing words may count for less if central banks’ inflation and labor-market objectives are realized or exceeded. As we discovered during the Fed’s 2013 “Taper Tantrum,” this is a difficult transition to make. There is a lot riding on it, given markets currently seem to be addicted to the liquidity and leverage in the system.