Lyn Alden, the founder of Lyn Alden Investment Strategy, says that with the Federal Reserve holding rates at near-zero, monetary policy is less important than fiscal policy when it comes to asset prices.
She explains that monetary policy is “about controlling interest rates and about doing asset purchases. Monetary policy historically is very good about putting the brakes on inflation, like we saw from Volcker in the 1980s. However, it’s not very good at generating inflation on its own.”
Fiscal policy, she points out, is about running deficits.
“Large deficits tend to be inflationary. Especially if those deficits are monetized by the monetary policy authority, the Federal Reserve or other central banks depending on the country in question,” she said.
Right now, with interest rates at near-zero, Alden says monetary policy is less important.
“There’s different periods of time where either fiscal policy is more dominant or monetary policy is more dominant. A lot of that has to do with where interest rates are. When interest rates are higher, the monetary policy makers have more tools in their tool chest. They can lower rates, they can do asset purchases. Where once those rates hit the zero-bound, their tools are pretty much extended at that point, they don’t really have a ton left on their own to do… when monetary policies run out of ammo, that’s usually when we see more fiscal spending.”
Not Much Inflation Soon
Alden says she doesn’t expect to see much inflation soon. This may happen due to stimulus money running out in July. Many expected that stimulus to create a surge in inflation.
“That had a reversal at the beginning of September, so inflation expectations were rising all year,” she said. “But then in the last month or so they’ve been on a downtrend again, Added also mentioned. “I think a lot of that is tied to the fact that stimulus isn’t really implied anymore. Most of the stimulus effects ended at the end of July.”
“So people are no longer getting stimulus checks, there’s no more PPP loans going out to small businesses turning into grants, there’s no more $600 a week in extra federal unemployment benefits, so all that stimulatory effect we had earlier in the year has not really been online for the past two months,” she said.
Inflation Depends on the Next Bill
With a renewed push for another stimulus bill, Alden says inflation expectations are starting to move higher. She says how high depends on the details of the next bill.
“We’re starting to see a bit of a rebound because I think the markets are expecting that stimulus has a somewhat higher chance of passing right now. Whether they will or not remains to be seen. So in the near term, this quarter or the next couple of quarters, a lot of the inflation outcomes will be tied to whether or not there's a new stimulus and how large and who it targets.”
Alden says a new round of stimulus that kicks inflation higher should be good for stocks. However, it would be bad for the US dollar.
“When you get that stimulus, that more inflationary impulse, it tends to be good for equities, especially some of the more value-oriented equities. It tends to be very good for precious metals because it can boost inflation expectations and therefore decrease the real yield on bank accounts and Treasurys. And it tends to be good for risk assets generally, and in particular some foreign stocks can do very well, particularly if the US is stimulating heavily and you get more weakness in the dollar.”
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