This week investors learned of president-elect Joe Biden’s initial bid for the next round of covid-19 relief. The number came in at $1.9tn. Importantly, included in this figure is mainly covid relief as opposed to a longer-term fiscal package that will be heavily weighted to infrastructure. In other words, it’s covid relief first (plus some goodies to satisfy the democrat base), followed by infrastructure and other structural spending later in 2021. Even if Congress won’t pass a $1.9tn covid relief bill, the final number is highly likely to be above $1tn. The longer-term package that includes infrastructure is likely to result in net spending of between $1-2tn, much of which is likely to be front loaded. Keep in mind also the $900bn in covid relief that was enacted in December. All in all, the US is likely to see fiscal stimulus up to ~10% of GDP in 2021 and another 5% of GDP 2022. This is on top of stimulus around 20% of GDP in 2020. This string of stimulus spending is simply unprecedented in peace time.
Now, we’ve been talking a lot about the possibility of the fiscal stimulus producing above-trend inflation for a period of time. Many pundits look back at the financial crisis period and point to the fact that, at the time, many investors also thought fiscal stimulus plus the Fed’s asset purchase program would lead to inflation. Asset purchases aside, fiscal stimulus during the financial crisis and years that followed amounted to less than half the stimulus as a percent of GDP than what will occur this time. Nevermind that fact that other catalysts for inflation exist today that have been absent in years past, including:
- Regionalization of supply chains
- Green energy policy that will put pressure on commodity prices from copper to lithium to nickel and cobalt. Indeed, EVs contain 183lbs of copper compared to 43lbs for combustion vehicles; wind turbines contain 800lbs of copper.
- Green energy policy that will seek to raise fossil fuel prices in general (either through taxes, a reduction in subsidies, or other hindrances to new production)
- Weakening USD from persistent budget and trade deficits (i.e. rising import prices)
- Room for the household savings rate (which is currently at 13%) to fall back to the 2-decade average of 6% (i.e. pent up demand)
Given the above, inflation is now a risk investors must consider and hedge for, which is different from any time over the last 20 years. So, what are the best hedges for inflation?