Optimism for US recovery but inflation fears mount

The Congressional Budget Office (CBO) forecasts the US economy will return to pre-pandemic levels by Q3 or Q4 of this year, helping to fuel market optimism. Much of that optimism is driven by the rapid roll out of vaccines but also that businesses have learnt to operate in a pandemic environment.

“Part of it is that we are better able to operate with the constraints that coronavirus puts on the economy,’ says Mark Vitner, senior economist at Wells Fargo. “We’re also expecting that coronavirus is going to become less of a problem over the course of 2021.”

It is worth noting that the CBO’s economic forecast does not account for the $1.9trn stimulus package being fast-tracked by the Biden administration. US Treasury Secretary, Janet Yellen has said the stimulus package would help the US return to full employment by 2022.

However, there are those that fear the proposed stimulus package could cause a rise in inflation.

“When all that spending does come back, I would expect inflation just to pop up pretty significantly,” says Vitner. “We are going to get a short-term pop in inflation because supply chains are being squeezed.”

If inflation spikes and interest rates are raised, there are several strategies corporates could use to hedge, according to Chris Campbell, chief strategist at Duff & Phelps.

“They could go to foreign exchange, foreign markets, maybe even Bitcoin or cryptocurrencies, though some more advisable than others. I think it prudent for treasurers and CFOs to plan for that eventuality, if Washington chooses to pass the [stimulus] bill.”

However, lawmakers in Washington may be unconcerned by a short-term rise in inflation because of how low it’s been, says Vitner.

“Policymakers seem not be afraid of inflation because it has been so low for so long. An overshoot, at least initially would likely be characterised with ‘okay, we’re just making up for lost ground.’”

Inflation over the past four years in the US has averaged around 1.23 percent – below the Fed’s 2 percent target, according to the OECD.

Getting to the new normal

Despite the economic fallout from the pandemic, compared with previous downturns, there are more reasons to be upbeat.

“Unlike 2008 and 2009, there really isn’t anything fundamentally broken with the US economy. We locked down the economy because we wanted to slow the spread of coronavirus,” says Vitner.

The US leads the G7 in terms of the pace of its economic recovery. Comparatively, the UK is set to be one of the last to recover from the economic impact of the pandemic with the Bank of England not expecting the country to return to Q4 2019 levels until Q1 2022.

“There’s still a lot of spare cash, a lot of ‘dry powder’ out there that I think is waiting to be deployed after we reach that new normal. There will be certainly a lot of opportunities for investment and for capital raising in the new world,” says Campbell.

Despite rising optimism for the US recovery, uncertainty over what the “new” economy will look like and slower recovery abroad will continue to keep cashflow management a priority concern for treasurers.

“The collective challenge to the US economy is we don’t know what the new normal is,” says Campbell.

“Cash management is going to be important until the end of this year, at least.”

It may take many months for a new normal to be established, however, as pent-up demand is likely to affect economic growth for several quarters, says Vitner.

“Pent-up demand will probably carry through most of 2022. The first year of recovery is where you see the strongest burst of growth. But given the constraints of the pandemic, we’re still going to have a large number of people that are going to be reluctant to travel or venture out all that much.”