Unintended consequences?

by: , Chief Investment Officer and Managing Director | IndexIQ; IndexIQ,

Inflation, an (un)intended consequence?

We’re old enough to remember when $1 trillion was a lot of money.

These days, that number is tossed around pretty lightly, with the U.S. Treasury now planning to borrow about $3 trillion to support the economy during the coronavirus pandemic. Another trillion or so of spending has been proposed by House of Representatives speaker Nancy Pelosi.  While deficit spending is clearly called for now, the longer-term impact of this level of borrowing on markets is unknown.

One thing we do know: there will almost certainly be some kind of unintended consequences. The unprecedented nature of the crisis and the magnitude of the resources being harnessed to combat it puts us well into uncharted territory and suggests that events will ultimately play out in unexpected ways.

The initial impact of COVID-19 has been heavily deflationary – millions of people out of work, companies forced into bankruptcy, yields on the 10-year treasury approaching zero – but that could change depending on the timing and the pace of the economic recovery. A rapid recovery in consumer demand coupled with massive fiscal stimulus could set the stage for broad-based price increases. As a thought experiment, investors may want to consider the potential impact that trillions of dollars in new government spending may lead to higher inflation levels over time.

For now, this is a somewhat contrarian point of view though it is gaining traction with a few market observers. A recent Bloomberg story quoted former International Monetary Fund Chief Economist Oliver Blanchard as saying that high inflation is “unlikely but not impossible.” (Bloomberg News Network: May 3, 2020) The argument goes something like this: the enormous fiscal and monetary stimulus being pumped into the economy is inherently inflationary; in spite of record unemployment there is actually some upward pressure on wages at the lower end as “essential workers” press for more compensation; disruptions in the global supply chain may lead to shortages in some areas, driving up prices; the repatriation of some essential production (if it happens) will locate it in higher wage countries, increasing costs; and, finally, governments will find it tempting to inflate away some of these huge new debts they are assuming.

For now, we, too, view higher inflation as a low probability outcome, but the probability isn’t zero. Inflation can be highly destructive to wealth so it’s worth giving some thought to protecting your portfolio, just in case. Gold has traditionally been one storehouse of value, but our research has shown that there are other ways of hedging that may be more effective.  Multi-asset class products offer exposure to commodities (including gold), currencies, commodity-based equities and even real estate with a goal of providing a “real return” – a return in excess of the prevailing rate of inflation.

It may seem a little strange to worry about inflation at the current moment. But good investors are always looking beyond the headlines. We have all been reminded again that events and markets sometimes move swiftly. Considering ways to mitigate a low probability but high impact outcome can be a prudent strategy.

The law of unintended consequences is front and center as we live through these challenging times. Now and then those consequences are meaningful. A reigniting of inflation would certainly be one of those times.

Past performance is no guarantee of future results, which will vary. All investments are subject to market risk and will fluctuate in value.

This material represents an assessment of the market environment as at a specific date; is subject to change; and is not intended to be a forecast of future events or a guarantee of future results. This information should not be relied upon by the reader as research or investment advice regarding the funds or any issuer or security in particular.

The strategies discussed are strictly for illustrative and educational purposes and are not a recommendation, offer or solicitation to buy or sell any securities or to adopt any investment strategy. There is no guarantee that any strategies discussed will be effective.

This material contains general information only and does not take into account an individual’s financial circumstances. This information should not be relied upon as a primary basis for an investment decision. Rather, an assessment should be made as to whether the information is appropriate in individual circumstances and consideration should be given to talking to a financial advisor before making an investment decision.

“New York Life Investments” is both a service mark, and the common trade name, of certain investment advisors affiliated with New York Life Insurance Company. IndexIQ® is an indirect wholly owned subsidiary of New York Life Investment Management Holdings LLC and serves as the advisor to the IndexIQ ETFs. ALPS Distributors, Inc. (ALPS) is the principal underwriter of the ETFs. NYLIFE Distributors LLC is a distributor of the ETFs. NYLIFE Distributors LLC is located at 30 Hudson Street, Jersey City, NJ 07302. ALPS Distributors, Inc. is not affiliated with NYLIFE Distributors LLC. NYLIFE Distributors LLC is a Member FINRA/SIPC.

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Salvatore J. Bruno

Chief Investment Officer and Managing Director | IndexIQ

Sal is Chief Investment Officer at IndexIQ, where his primary responsibility includes developing and maintaining the firm’s investment strategies. Sal joined IndexIQ in 2007 from Deutsche Asset Management (DeAM) where he held a number of senior positions

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IndexIQ, a New York Life Investments Company, is a trusted provider of innovative financial solutions. IndexIQ ETFs are built and delivered in a way that provides exposures that investors can rely on. A subsidiary of one of the oldest and largest life insurance companies in the world, we have a solid foundation and the resources to continue our culture of innovation…

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