Not since World War II ended has America’s supply chain experienced the degree of disruption that it is today as the economy emerges from the pandemic in fits and starts. Indeed, a raft of recent commentary drawing comparisons of today’s herky-jerky reopening to 1970s stagflation or the Roaring 1920s may be focusing on the wrong decade.

Circumstances were very different 75 years ago in the late 1940s, but supply chain bottlenecks spawned severe inflation. For the 12 months ending in March 1947, the Consumer Price Index soared 20.1% as wartime price controls and rationing were lifted. This rampant inflation proved to be short-lived, and the CPI fell 2.9% for the 12 months ending July 1949. Still, inflation averaged 5.8% for the decade between 1941 and 1951, according to the Bureau of Labor Statistics, before petering out in the 1950s.

Back then, the challenge was the demobilization of millions of troops and a shift from a wartime to a peacetime economy. Today, the problems revolve around reopening an economy scarred by the trauma and mandated shutdowns of a public health crisis. For better or worse, the U.S. is leading the way again as the rest of the world appears to be lagging behind in vaccinations, a key recovery metric this time around.

Most baby boomers nostalgically but inaccurately view the post-World War II era as one of brisk economic growth. In reality, GDP growth averaged 1.8% from 1945 through 1953 under President Truman and 2.4% from 1953 to 1961 under President Eisenhower, according to data compiled by Bloomberg Opinion’s Justin Fox. America’s population did boom, but the bulk of that gain came from babies, not the most productive citizens.

On a socio-political level, turbulence was equally pervasive 75 years ago. In 1946, Republicans won 54 seats in the House of Representatives and 11 seats in the Senate, taking control of both chambers. Two years later, Democrats retook both with gains of 75 House seats and nine in the Senate.

Markets Snicker At Inflation Fears
A major disconnect perplexing asset managers is the refusal of the bond market to recognize the rampant price inflation Americans are experiencing in many of their daily activities. Many blame the Federal Reserve for maintaining artificially low interest rates. Others buy into the Fed’s argument that current price trends are “transitory.”

Factors besides central bank manipulation may be at play. Manhattan Institute economist Allison Schrager notes that if bond traders turn out to be dead wrong it would hardly be the first time. After trends like low interest rates and inflation have been entrenched for so long, markets may fail to realize a sharp shift when it surfaces.

Simple supply-and-demand dynamics are also driving markets. Loomis Sayles Vice Chairman Dan Fuss says his firm’s bond traders see a steady stream of money flowing into U.S. markets from East Asia. In the 1930s, European investors facing darkness loom over their continent poured money into the U.S. and Canada. Today, China’s crackdown on wealthy business owners is rippling throughout its neighborhood.

Corporate America’s love affair with just-in-time inventory is over. Fuss notes many companies were seeking to bring their supply lines closer to home for several years before the pandemic, and that will increase costs.

As America emerges from the pandemic, many economists are starting to think that while commodity inflation may be short-term, wage inflation, which isn’t subject to the same up and down swings as raw goods and materials, will stick around. Structural changes in the labor market are likely to determine the shape of both inflation and the recovery as workers gain negotiating power from looming labor shortages.

Some of these changes have already arrived, particularly at the low end of the income spectrum.

Since Covid-19 began, Amazon has hired nearly two million workers at $16 an hour.

The average supermarket worker is now earning over $15 an hour and, even so, many retail and hospitality employers are struggling to find workers. A recent survey of employees in these sectors found half of them view the recovery as an opportunity to get better jobs.

Many workers in information-based businesses have benefited during the pandemic, and some employers in these industries are upping the ante pre-emptively. BlackRock, the world’s largest asset manager, recently announced an 8% raise for all employees.

Where inflation settles down is anyone’s guess. Fuss expects prices to moderate from recent levels but still run at a 4% or 5% clip for the next several years.

Others, like DoubleLine’s CEO Jeffrey Gundlach, have discussed similar numbers in recent webcasts, though Gundlach declined to put a time line on his prediction. While that would not be a return to 1970s style inflation, it still represents a sea change from what markets and businesses have grown accustomed to.

The Fed has given a convincing performance on selling the “transitory” narrative, notes Permanent Portfolio CEO and CIO Michael Cuggino. But masterful salesmanship doesn’t always translate into actual outcomes.

If the paycheck component of inflation stays around longer than people anticipate, it will start to change the behavior of consumers, businesses and workers, Cuggino explains. “The longer the data is there, the more likely it is to get embedded into businesses’ psychology,” he says.

Perception Meets Reality
It’s when those expectations are contrasted against what the bond market is pricing that the chasm between perception and reality gets glaring. MFS Investment Management chief economist and portfolio manager Erik Weisman has more muted inflation expectations than Fuss, Gundlach and others. Still, he thinks pricing in the market for Treasurys and other bonds borders on the irrational.

“All 18 governors and presidents of the Fed thought inflation would be lower,” he says, though they expressed less certainty about its path. Even if sustained 4% inflation doesn’t materialize, Weisman thinks bond investors could get clocked if it runs at a 2.5% rate.

It’s worth noting that a 2.5% yield on 10-year Treasurys would still rank in the lowest decile over the last 70 years, Weisman continues. But a historically modest rise in 10-year Treasury yields to 2.5% from 1.3%, where they stood in mid-August, would sock investors with an 8% or 9% loss.

If one goes back 18 months to February 2020 before the outbreak of the pandemic, the economy is running a lot “hotter than it was then,” Weisman continues. Given the amount of stimulus and liquidity in the system, that’s likely to continue for the next year, barring the outbreak of a nasty, new variant.

If the market turns out to be right, what developments could it be pricing in? One possibility is a quick economic slowdown, Cuggino says. If Covid keeps mutating, that could happen.

There are several other possibilities in Weisman’s view. Perhaps the market is reasoning that the Fed will have to raise rates and “things will peter out” and the economy will enter a recession in 2024 or 2025.

There’s another, possibly much more robust scenario, one Weisman doesn’t mention: one in which the forces of technology and globalization—the things that caused disinflation for the last three decades—will reassert themselves and trump shortages in the labor and commodity markets.

But there are other ramifications if current market conditions remain. Specifically, Weisman says, if negative real rates become a permanent fixture on the financial landscape, allocating capital will become a daunting challenge.