Inflation debate divides Wall Street with some seeing danger, while others say the game has changed

Published Tue, Sep 15 20202:11 PM EDTUpdated Tue, Sep 15 20202:34 PM EDT

Patti Domm @in/patti-domm-9224884/@pattidomm

Whether the Federal Reserve's policies and massive U.S. debt are the kindling for an inflationary fire has yet to be seen, but the very idea the U.S. could face a spiral of rising prices is a topic dividing Wall Street. Some big investors believe spiking inflation could become a problem. Billionaire hedge fund manager Stanley Druckenmiller, for one, says the Fed's actions and congressional spending could take inflation to 5% to 10% in the next four to five years. But others believe the world has changed. With technology and big data speeding change and lowering costs, the pressures of the past are no longer as worrisome. The impact of the pandemic also sped some change, such as telemedicine and more virtual meetings and internet-based learning. America hasn't seen high inflation in more than a generation. The worry is that rising prices squeeze business profits, hurt consumers and undercut retirees' savings. "I just don't buy the argument that we're going to have runaway inflation any time soon because of all the factors that will bring your costs down," said Rick Rieder, chief investment officer of global fixed income for BlackRock. "You can argue parts of health care and parts of education, those costs are coming down as well. I think you're seeing more technologies and efficiencies." Since the financial crisis more than a decade ago, inflation has rarely hit the Fed's 2% target. This week, the Fed is meeting, and Fed Chairman Jerome Powell is expected to discuss its new policy of an average inflation target at his Wednesday afternoon press briefing. The Fed's new policy means it would allow inflation to rise above the target, without moving immediately to tighten policy — or raise interest rates from its current level of zero. But the Fed's easy money policies, which have fueled the stock market's gains and eased credit conditions, are seen as the stuff bubbles are made of — and also fans for inflation. The Fed's asset purchases have ballooned the Fed's balance sheet to $7 trillion. At the same time, the U.S. deficit has hit $3.5 trillion and ever more Treasury issuance is needed to pay for it. "We actually have the chairman of the Federal Reserve with a $3.5 trillion deficit out lobbying Congress to do more spending and guaranteeing those of us on Wall Street that he'll underwrite it. I think it's dangerous," Druckenmiller said on CNBC. Powell has said the Fed's bigger concern is disinflation with millions still unemployed and the pandemic still hobbling the economy. Traditionally, a slightly higher rate of inflation is seen as a positive. It signals a healthier economy, where interest rates can rise. It also gives businesses more pricing power and should help lift workers' wages. "I think longer-term people are going to start questioning why do you need to have inflation above 2%," said Rieder, adding the Fed may ultimately move on rates because of financial conditions, not rising prices. "If new technology is being used to bring down the costs of goods, why isn't that good for the consumer?" "I think the coronavirus put into hyper speed how companies can operate more virtually. Now costs can be brought down and businesses that are driving it are the big winners," said Rieder. Rieder said the old adage that higher wages meant inflation hasn't turned out to be right. He said the theory that rising debt will devalue the currency may also be wrong. "I think there could be more inflation. I think there is probably an environment for a bit more inflation, given the amount of debt and probably a moderately lower dollar, but there are so many reasons for the dollar to stay supported, given that 70% of the world is indexed to the dollar. Much global trade is tied to the dollar," he said. Both the August consumer price index and producer price index showed higher than expected gains last week. PPI's 0.3% month over month rise was fueled in part by medical costs, and CPI included a 5.4% jump in used car prices. CPI was up 0.4% , and 1.3% higher year over year. Core personal consumption expenditures prices, watched by the Fed, were up 1.3% in July. "If more investment comes because you can operate efficiently and drive down costs, why is it inflationary? Meaning deflationary expectations drive investments," said Rieder. "I thought the CPI report was right down the fairway to illustrating why inflation as a goal is ambiguous. Why are we cheerleading higher used car prices? Is the Fed moving closer to target? If you look at companies that are performing well, so many of them are companies that drive efficiencies, whether it's Amazon or Google." He said the next generation of companies using Google's technology or the Apple App store will continue to make a difference. Instead of growing profits with higher prices, companies benefit with margin improvements. "If you take the top performing stocks, the ones that make your life efficient, I think the next step is the new businesses and the new companies that are using the platforms, that use the data," he said. "I think there's a generation of companies that are going to come to market and create these massive efficiencies." He pointed the example of DraftKings, a sports betting operator, which went public in April and has a bigger market cap than classic casino companies that have been around for decades. "You can create scale unbelievably quickly," he said. "It's the next generation of who can get scale and use data." The tech sector has been viewed as sector of the stock market that's been particularly bubbly, gaining far more than other stocks and pushing the market indexes higher. Rieder said some of those stocks have gotten overpriced, but the stock market got it right in terms of rewarding those Big Tech names. Market prices low inflation The Fed watches inflation expectations, which can be survey-based or market-based. Market-based expectations now show investors betting on a low pace of inflation, at around a 1.5% annual pace for the next five years. But investors have been actively investing with inflation in mind, based on the large interest in TIPS, or Treasury Inflation-Protected Securities. Comments from Fed Governor Lael Brainard acknowledge that inflation has not behaved as expected for a long time. She recently noted that the tight labor market, pre-Covid, did not create price inflation, as economists would have expected. She said that means the labor market can improve for longer without generating inflation, and other Fed officials have also made the point that letting inflation run a little higher than its target could help the employment picture. "The near decade of inflation persistently short of 2% creates the risk that households and businesses come to expect inflation to run persistently below target and change their behavior in a way that fulfills that expectation, which greatly complicates the task of monetary policy," Brainard said in a recent speech. Another factor impacting the inflation picture is energy costs, which are down sharply year over year but have been rising in the last several months. Energy is down 9% for the year, and gasoline costs are down 16.8%. Some goods that had become scarce and became more expensive during the pandemic, like beef , declined in price in the summer. Beef was down more than 8% in July and 4.4% in August. But dairy products rose by 1.5% in August, and the cost of food at home rose by a half percent. "We are seeing inflation in some parts of the economy so you're seeing it in airfares, motor vehicle insurance, apparel," said Mark Cabana, head of U.S. short rate strategy at Bank of America. But he said real estate owners' equivalent, rent, is not likely to rise, with oversupply of apartments in some cities and some tenants still not able to pay rent. "We are not particularly worried about inflation. We are much more worried about disinflationary pressures, as opposed to inflationary pressures in the near term," said Cabana.

Shoppers search for items at a Costco Wholesale store August 4, 2020 in Colchester, Vermont.

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Some big investors believe spiking inflation could become a problem. Billionaire hedge fund manager Stanley Druckenmiller, for one, says the Fed's actions and congressional spending could take inflation to 5% to 10% in the next four to five years.

But others believe the world has changed. With technology and big data speeding change and lowering costs, the pressures of the past are no longer as worrisome. The impact of the pandemic also sped some change, such as telemedicine and more virtual meetings and internet-based learning.

America hasn't seen high inflation in more than a generation. The worry is that rising prices squeeze business profits, hurt consumers and undercut retirees' savings.

"I just don't buy the argument that we're going to have runaway inflation any time soon because of all the factors that will bring your costs down," said Rick Rieder, chief investment officer of global fixed income for BlackRock. "You can argue parts of health care and parts of education, those costs are coming down as well. I think you're seeing more technologies and efficiencies."