Given current household leverage from mortgage and consumer debt, coupled with the inability to access mortgage equity withdrawals (that largely fed spending increases during the most recent economic expansion), my concern continues to be that unemployment will behave as a leading indicator rather than a lagging one. During typical economic downturns, there is always some feedback from employment losses to credit losses, but that effect has been more contained because debt burdens have not been nearly as high, and homeowners have not been saddled with negative home equity. The dynamic of this downturn is different, so investors should be slow to accept the “employment is a lagging indicator” argument under present conditions.
On the inflation front, I continue to believe that any persistent inflation pressure is most probably several years out. The primary inflation risk is not simply that the Treasury and Federal Reserve have dramatically expanded the volume of government liabilities. To the extent that these agencies have taken assets in – commercial mortgage securities or preferred stock of banks – these transactions could theoretically be reversed without leaving a persistent increase of government liabilities in their wake. The real problem is that avoiding inflation here requires that these transactions can be undone, and that will prove impossible if mortgage defaults do not actually stop. There is no reason to believe that they will, particularly given the enormous overhang of second-wave mortgage resets that will begin later this year. So the real problem is not just that we've issued more government liabilities, but that the assets that we've taken in return will turn out to be worth less than the liabilities we created. The difference, of course, will represent pure money creation, and that's what will feed inflationary pressures over time.