New virus variants will continue to prevent a complete opening of the global economy. Europe’s vaccination gap to the US has narrowed considerably. Inflation risks are high. A scaling back of highly stimulative monetary policies is not yet in sight. The recovery of the US labor market is slower than “the consensus” expected. Although more than 7 million jobs have been lost since the start of the pandemic, US wage inflation looks set to rise. The coming rise in consumer price inflation will be less transitory than central banks would have us believe.
New virus variant B1.617
New mutations of Covid-19 are emerging all the time. The new Indian variant, B1.617 is not only more transmissible than other variants, its ability to evade our immune systems is very uncertain. Thus, pre-existing concerns about the durability of the vaccination protection remain valid. Depending on infection rates, new travel restrictions may be imposed in future. France, for example, wants to introduce additional restrictions for those arriving from the UK to combat the “Indian variant”.
US-Europe “vaccination gap” has been reduced
It is encouraging that the lag between the US vaccination program and that of Europe has decreased significantly. In Germany and Switzerland respectively almost 45% and over 34% of the population have already received one vaccine dose. In the US over 50% of adults will soon have received two doses. Infection rates are clearly on the decline, albeit that these are favorably impacted by warmer weather. Much lower incidence figures have made it possible to open up the hospitality industry and increase the chances of a holiday season that is only partially disrupted. The opening of those parts of the economy most affected by lockdowns has now extended even to the aircraft manufacturers. Airbus plans to increase monthly aircraft production from the current 45 to 64 as of 2023 and to 75 by 2025. (At the end of 2019, 45 aircraft per month were being produced.) Thus, optimism has returned, at least in Europe’s aircraft industry.
No “all clear” elsewhere
Unfortunately, there is no all-clear in the developing world, especially in India but also in Asia generally. In Vietnam and Thailand, numbers are skyrocketing, with record numbers of deaths cited.
In Australia, Melbourne has recently decided to implement a further lockdown. Meanwhile the virus in Africa seems scarcely to have been addressed and is probably grossly under-reported.
But a sustained global “all-clear” on the virus front would trigger warnings on the monetary policy front
We think a world in which governments could quickly end all lockdowns would be one confronted by economic overheating and more restrictive monetary policies worldwide. We do not view this scenario as likely in the near-term because politicians will have to keep introducing new lockdowns and partial travel restrictions due to future virus mutations.
Despite highly expansionary fiscal and monetary policies, a real economic boom is still not in sight. Current high growth rates, reflecting a recovery from last year’s economic collapse, will fall significantly within 3-6 quarters at the latest. Thus, we do not see the central banks “taking their feet off the accelerator” for the time being. The Fed has only begun to indicate that at some point it “will have to talk about” starting to scale back its liquidity programs. Unfortunately, the preceding sentence is not a joke. Its twisted language reflects how desperate monetary policy has become.
Fed’s balance sheet is heading to US$ 9,000 bn.
The New York Fed assumes that the balance sheet of the Federal Reserve should amount to around US$ 9,000 bn. towards the end of 2022. This projection assumes that the Fed will continue for the time being to purchase government and securitized mortgage bonds worth US$ 120 bn. per month but that after 6 months purchases will be slowly “tapered”, i.e., slowly reduced. At the beginning of 2020, the Fed’s balance sheet totaled US$ 4,100 bn. It is currently around US$ 8,000 bn.
Inflation risks are high
Some sectors in the US, notably retail, hotels and restaurants, have seen a rise in wage inflation. Even if current additional unemployment benefits are phased out, there is a risk that wages will continue to rise, as expected inflation is still on the rise and wage negotiations are ultimately about real purchasing power and not nominal wages.
US labor market again falls short of high expectations
The Bureau of Labor Statistics announced that “only” 559,000 new jobs were created in April, instead of the 650,000 expected. Compared to the pre-pandemic employment level in February 2020, some 7.6 million American jobs have been lost on a net basis. Thus 1 million jobs would have to be created on a monthly basis for nearly 8 months to reach the old employment level! But America’s labor market is not “weak enough” to prevent a rise in wage inflation.
State introduces a “hidden” tax
An ultra-stimulative monetary policy will lead to a significantly higher inflation rate in the longer term. As a rule, this only happens once a so-called “wage-price spiral” is set in motion. Central bank communication aimed at keeping inflation expectations low have only succeeded to a limited extent. With a significant increase in expected inflation evident in practically all countries, wage negotiations are set become more “aggressive”, with calls to compensate for higher inflation becoming louder.
Moreover, signs are accumulating that consumer prices will rise significantly in coming months: producer prices in China, the US and Germany are all currently increasing by over 4% year-on-year. Commodity prices are showing significant increases with freight prices “shooting through the roof”. In summary: price pressure at the beginning of the production chain is high and will be reflected at the end of the production chain in higher consumer prices with a delay. Actually, this is what the central banks and fiscal policy makers want, even if they claim the opposite. After all, the goal of monetary and fiscal policy makers is to generate unexpectedly high inflation in order to combat the over-indebtedness problem of governments and, in real terms, to deleverage. Inflation is a “hidden tax” – a real devaluation of savings held in nominal assets. All contracts that do not contain inflation compensation clauses (and such contracts are forbidden in most developed countries) become less valuable to creditors (e.g., lenders to the state) and more valuable to debtors (e.g., the state itself), as debt burdens shrink in real terms. Those who love fairy tales should therefore read the more exciting and linguistically superior folk tales, for example by the Brothers Grimm, instead of central bank communiqués. Due to tax progression and the taxation of nominal incomes, private households automatically increase their tax rate if they manage to negotiate at least a part of inflation into higher nominal wages. The same mechanism also transfers more resources into the hands of state bureaucrats.
Switzerland ends talks on a framework agreement with the EU
Seven years of talks on an institutional framework agreement with the EU ran into the sand and the negotiations were broken off by Switzerland. The EU has announced that it will no longer automatically renew expiring bilateral agreements. We think the effects on the Swiss economy will not prove serious. Most bilateral agreements are likely to be renewed, albeit after a lot of wrangling.
Contact: Thomas Härter, CIO, Investment Office
Telephone: +41 58 680 60 44
Disclaimer: Produced by Investment Center Aquila Ltd. Information and opinions contained in this document are gathered and derived from sources which we believe to be reliable. However, we can offer no under-taking, representation or guarantee, either expressly or implicitly, as to the reliability, completeness or correctness of these sources and the information pro-vided. All information is provided without any guarantees and without any explicit or tacit warranties. Information and opinions contained in this document are for information purposes only and shall not be construed as an offer, recommendation or solicitation to acquire or dispose of any investment instrument or to engage in any other trans action. Interested investors are strongly advised to consult with their Investment Adviser prior to taking any investment decision on the basis of this document in order to discuss and take into account their investment goals, financial situation, individual needs and constraints, risk profile and other information. We accept no liability for the accuracy, correctness and completeness of the information and opinions provided. To the extent permitted by law, we exclude all liability for direct, indirect or consequential damages, including loss of profit, arising from the published information.
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