When Democrats passed the CARES Act in January 2021, it was first seen as a political achievement. Query of Politico/Morning Consult showed 75% of registered voters backed the bill three months after it was passed. Meanwhile, Democrats began touting President Biden as the next Franklin D. Roosevelt. The legislation was so popular that the politicians who voted against the package started taking credit for it. However, the bill may have had an unintended consequence. The fiscal stimulus injected new money before the global economy was ready to absorb it. While domestic companies had low inventories, the pandemic prevented foreign companies from operating at full capacity. Thus, the American desire for goods led to higher global inflation, as businesses could not provide the supply needed to offset the demand created by the new stimulus injected. Moreover, the trade deficit has reached an all-time high, as excessive demand has led to an increased need for imports. In this report, we examine how the CARES Act has contributed to the widening deficit and an increase in property inflation. We will also explain how we anticipate countries will seek to reverse some of the impact of the bill and conclude with possible market ramifications.
Following the passage of the CARES Act, Americans have struggled to find places to spend their extra cash. Due to pandemic restrictions, the availability of services was severely limited. In the first few months of 2021, restaurants saw fewer customers, airlines offered fewer flights and sporting events were, for the most part, uncrowded. With limited entertainment and travel options, consumers have spent most of their new money on durable goods. Last year, purchases of motor vehicles and leisure items reached levels not seen in pre-pandemic times.
The strength in spending in the first quarter of 2021 caught many companies off guard. The year before, when the United States went into lockdown, companies sold off inventory, thinking the pandemic recession would be long-lasting. Car rental companies have been particularly active as lack of travel has forced them to keep vehicles, a depreciating asset, on their balance sheets for an unforeseen length of time. Thus, these companies were motivated to sell their vehicles. Activity was so noticeable in 2020 that the United States recorded its first trade surplus in Motor vehicle parts and engines since the Great Financial Crisis. The lack of available inventory carried by companies due to this selling activity contributed strongly to the demand pressures observed the following year.
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Although consumers contributed to the jump in demand in the first quarter of 2021, consumer data from March suggests that businesses have also increased their spending. At the start of the spring season, higher vaccination rates encouraged states to ease COVID-related restrictions. Consequently, companies that expected a travel rush, particularly in the leisure and hospitality industry, increased their spending on equipment and labor. This spending likely drove the rebound in durable goods from a lull in February to its highest level of the year in March. The aforementioned car rental companies were spending a lot during this time. The lack of available cars has forced these companies to buy used cars, which they usually try to avoid. Automotive consumption accounted for almost half of total spending on durable goods in March. As a result, the price of new and used cars skyrocketed in 2021 and is currently one of the main contributors to inflation.
While the United States boosted its economy, the rest of the world was still reeling from the pandemic. The difference in results was likely related to the successful development and delivery of COVID-19 vaccines. In early 2021, Americans found it relatively easy to sign up and get their first shot. Meanwhile, Europe struggled to distribute vaccines, Asian populations were hesitant to get vaccinated, and African countries struggled to procure vaccines. The emergence of the Delta variant made matters even worse. The new variant has led to an increase in the number of cases and has severely hampered countries’ efforts to reopen their economies. Shipments were delayed because ports closed and arbitrary quarantines led to constant labor shortages and, in some cases, factory closures. These pandemic-related disruptions meant that foreign suppliers could not produce at levels sufficient to meet US demand for foreign goods. This had a negative impact on the global economy.
The combination of a lack of global production capacity and strong US demand for inventory has put upward pressure on prices for goods and services around the world. The most notable price increase came from materials, as demand for industrial supplies rose sharply. Natural gas, steel and crude oil were in exceptionally high demand as companies needed raw materials to ramp up production. Global demand for materials was so strong that the United States recorded its largest trade deficit for industrial supplies in at least 20 years, despite traditionally being a net exporter of this group of commodities. Firms began to look for other sources of inputs, in some cases placing multiple orders with different suppliers. In other cases, they shipped inputs by air freight rather than by ship. These orders may explain at least in part why companies, with the exception of automakers, are currently holding high inventory levels. Thus, much of the rise in the US deficit for goods can be attributed to companies receiving multiple orders for the same goods from different suppliers.
US demand for foreign goods may have pushed global prices higher, but it will likely take a global effort to contain these price increases. To combat rising global inflation, we suspect that central banks around the world will begin to tighten monetary policy. Rising interest rates should ease some of the pressure from demand for goods and ease some of the inflation. However, the main driver of disinflation is likely to come from countries easing pandemic-related restrictions and allowing businesses to operate at full capacity. In the meantime, we think conditions are supportive for financial sector stocks and commodities. Higher interest rates should make it easier for financial institutions to increase their margins without taking on too much risk, and continued commodity demand will likely continue to support commodity prices through 2022.
These reports have been prepared by Confluence Investment Management LLC and reflect the current opinion of the authors. Opinions expressed are current as of the date indicated and are based on sources and data believed to be accurate and reliable. Opinions and forward-looking statements expressed are subject to change. This is not a solicitation or an offer to buy or sell securities. Past performance is not indicative of future results. The information provided in this report is for educational and illustrative purposes only and should not be construed as individualized investment advice or a recommendation. Investments or strategies discussed may not be suitable for all investors. Investors should make their own decisions based on their specific investment objectives and financial situation.