Policymakers are making a big gamble that their extraordinary efforts to stimulate the U.S. economy will not send inflation out of control, but one of the biggest bond fund managers says its an open question if their wager will pan out.
“We had this massive helicopter drop of money without creating more productivity capacity on the other side of it. The big policymaker bet was that by driving demand through the roof, you’re going to incentivize suppliers to expand capacity,” said Tad Rivelle, chief investment officer of fixed income at TCW Group and manager of its $88 billion Metropolitan West Total Return Bond Fund, once the biggest active fixed-income fund.
The non-partisan Congressional Budget Office projects a federal budget deficit of $2.3 trillion in 2021. At 10.3% of gross domestic product, the deficit in 2021 would be the second largest since 1945, exceeded only by the 14.9% shortfall recorded last year.
Meanwhile the Fed has expanded its balance sheet from about $3.7 trillion in September 2019 to about $7.7 trillion in April this year, as it has bought government and mortgage bonds and taken other measures to support the recovery from the coronavirus pandemic.
“This is a massive experiment, so to speak, that you can in effect insulate the economy from basic fundamental change,” said Rivelle.
But he felt the ability of supply to catch up with demand was in doubt, especially when a “lot of producers are up to their eyeballs in leverage.”
He pointed to the example of U.S. semiconductor manufacturers who are faced with chip shortages who may be slow to boost costly investments in foundries, especially if they feel the supply constraints may prove temporary.
The lack of supply was also evident in shortages of manufactured goods and commodities, with prices for used cars, lumber and homes skyrocketing as the economy recovers from the coronavirus pandemic.
See: The biggest ‘inflation scare’ in 40 years is coming — what stock-market investors need to know
Without production adjusting in time, supply issues could contribute to more pernicious price pressures, he said, a point of fierce contention among some economists and the Federal Reserve. Philadelphia Fed President Patrick Harker said last week that he didn’t see inflation getting out of control, and that the forces that might lift prices in the coming months may lose steam by the end of the year.
Like former U.S. Treasury Secretary Larry Summers, Rivelle fretted efforts by fiscal and monetary authorities to boost demand, if continued, could see their comeuppance with higher inflation.
See: Summers says Fed should express more concern over inflation outlook
“When you start to shake that foundation of trust by committing yourself to a sequence of what will ultimately be policy errors … that is the inflation risk out there,”…
Read More: ‘Massive helicopter drop of money’ from Fed and Washington raises inflation