• How and where we work will likely be permanently altered: Multiple recent surveys have shown that most employees who were forced to switch to remote work by the pandemic feel the change has largely been productive and would prefer a remote or hybrid model going forward (See PwC’s U.S. Remote Work Survey, January 12, 2021, Pew Research Center, December 9, 2020 and Harvard Business School Online Survey, March 25, 2021). While maintaining motivation and a corporate culture requires some in-person interaction, particularly for younger employees, the forced adoption of work-from-home technology will likely permanently reduce the demand for office space. This could also alleviate peak-hour traffic congestion and the need for new physical infrastructure. A similar argument can be made for business travel, which will likely be permanently reduced by the adoption of virtual technology.
• Cheap labor will become increasingly scarce: While Federal Reserve officials might argue otherwise, there is clear evidence that a tightening U.S. labor market was adding to wage growth prior to the onset of the pandemic. A very quick recovery from the pandemic will mean much less time for labor market slack to erode wage growth as, of course, will generous unemployment benefits. In addition, a sharp decline in immigration, even before the pandemic, is limiting U.S. labor supply and the highly political nature of the immigration debate suggests that this trend may continue for some time. All of this points to stronger wage growth in the wake of the pandemic. Conversely, very easy monetary policy could continue to fuel investment in labor-saving technology, such as robotics and artificial intelligence. This could herald the arrival of stronger productivity growth across the economy.
• The risks of higher inflation and interest rates have increased: The failure of monetary stimulus to generate either stronger economic growth or higher inflation in the last expansion has resulted in even more dovish Federal Reserve policies. Meanwhile, political populism on both the right and left has reduced concerns about rising government debt. Both of these trends suggest that debt will increase and monetary policy will remain very easy until inflation is steadily above the Federal Reserve’s 2% long-run target for the personal consumption deflator. Indeed it is worth noting that the personal consumption deflator posted a 3.6% year-over-year increase in April. If prices, by this measure, rise by just 0.2% per month for the rest of the year, inflation will still be 3.2% year-over-year by the fourth quarter of 2021.
There is now a very good chance that real economic growth will be stronger, unemployment will be lower and inflation will be higher in the fourth quarter of 2021 than current Federal Reserve projections. This could well force the Fed to taper bond purchases in late 2021 or early 2022 and raise the federal funds rate in late 2022 or early 2023. These moves, in turn, could push long-term interest rates significantly higher than the current 1.58% yield on 10-year Treasuries.
The last year and a half will have enduring effects and the economic and financial landscape that emerges in wake of the pandemic will be very different, for better and for worse, from that of the late teens. However, some rules will endure.
One of them is that the value of any financial asset must equal the discounted value of the cash flows that that asset can generate. Higher interest rates will increase those discount rates and should put additional stress on those assets whose perceived value depends most on increasingly speculative cash flows stretching far into the future. As investors prepare for a new post-pandemic reality, a focus on valuations will be more important than ever.
David Kelly is chief global strategist at JPMorgan Funds.