Corporate Buybacks, Rising Rates, And Commodities

To the extent that some of this debt is funded at shorter-term rates, as rates head higher, interest payments will also start to head higher, Adams stated. At that point, questions of how we fund these obligations will become more pressing.

The primary concern revolves around how to pay for these increases without eating away at other government expenditures and government programs.

“That's the trigger point,” Adams said. “It does provide a good case for why you want to watch rates longer term. Obviously, real rates are still very far in negative territory. Even though longer-term interest rates are rising, they're still extremely low. So it's not a concern in the immediate term, but ultimately, rates will move up. And if rates move up faster than economic growth moves up, we suddenly have to contend with how we pay for all of this debt that we've taken on.”

From Reflation to Inflation

How all of this plays out certainly revolves around what happens with inflation, Adams noted, and we need to watch expectations and actual inflation metrics closely.

However, despite the monetary growth we’ve seen, and despite the Fed’s extraordinary efforts to support economic conditions throughout 2020, even though M2 is exploding, the actual velocity of money is not.

Until we see money velocity increase, a true outbreak of inflation is unlikely, Adams noted.

The most recent producer price print was still less than 1 percent year-over-year, and consumer prices are growing at about 1.5 percent year-over-year. These are very benign conditions, Adams stated, even compared to other time periods in which inflation conditions were accelerating over the last 10 years. See Felix Zulauf Interview on Massive Stimulus vs. Deflationary Population Trends

Ultimately, the evidence for inflation is still subdued. It is still important to watch for policy errors that might create inflation, and this is the reason markets remain somewhat sensitive to the Fed.

Markets will continually ask if the Fed has it right as to whether any near-term reflation in the economy will be deemed transitory inflation, or if something more ominous is occurring. That is going to be a big part of the conversation over the course of the next year.

“So far, it’s a story of reflation, not inflation, which is very supportive for stock prices and probably also keeps any sort of increase in rates generally at bay,” Adams said. “One of the things that we're going to contend with … is supply-based inflation, where supply chain disruptions in general resulted from COVID shutting down trade. … As a result, we've been left with limited supply of certain products globally. In an environment where demand advances and you have limited amount of supply, you can have temporary price increases. In the United States, the vast majority of what we spend is actually on services, and services don't seem to be tremendously constrained relative to demand right now. So we shouldn't see an absolute breakout in prices and inflation. But it certainly is something we want to watch for, and it would likely be one of the predominant reasons for an unforeseen move higher in rates.”

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