The aggressive monetary and fiscal response to the coronavirus crisis in the United States could trigger a surge in inflation that the Federal Reserve may find it difficult to control, according to Morgan Stanley. This, the bank said, could turn the stock market upside down.
Citing economist Milton Friedman’s saying that “inflation is always and everywhere a monetary phenomenon,” Morgan Stanley chief US equities strategist Mike Wilson pointed to a surge in money circulating in the economy. economy of the country.
The annual growth of M2 – a large measure of America’s money supply – has exploded this year due to efforts by monetary and fiscal policymakers to reduce the economic damage caused by the pandemic. Although the severity of the shock makes deflation the most likely short-term outcome, Wilson argued that there is now a “greater likelihood of inflationary pressures building up.”
“While we are likely to experience big imbalances in the real economy for several more quarters, if not years, the most powerful leading indicator of inflation has already shown its hand – money supply, or M2,” Wilson said.
The Fed eased its monetary policy sharply after the 2008 financial crisis, and fears of faster inflation did not materialize. However, Wilson points to the US government’s much more aggressive fiscal response this year, which ranges from massive loan programs for stricken businesses to stimulus checks for households.
He also says that banks are in much better shape than they were in 2008, making it more likely that the money supply will remain high.
For stocks, faster inflation generally tends to be positive as their earnings rise with higher prices and fixed coupon bonds become less attractive. But there could be an upheaval in the stock rankings, Wilson said. “Perhaps the problem is that the equity market leadership is skewed in favor of deflationary winners, which makes any sudden surge in inflation quite disruptive for portfolios,” he warned.