Stimulus, inflation, and you

Federal stimulus may fuel inflation. Learn how to protect your investments.

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Key takeaways

  • The new $1.9 trillion stimulus spending package, on top of trillions already spent to revive the economy, is driving the national debt to unprecedented levels.
  • History shows that high government debt often leads to inflation, and an uptick in inflation is expected this year as the economy recovers.
  • Looking to hedge against inflation? Non-US and low-priced value stocks as well as Treasury Inflation-­Protected Securities (TIPS) and commodities may benefit from rising inflation.

The $1.9 trillion federal stimulus package will help many families, businesses, and state and local governments hard hit by the pandemic. But it is also fueling concerns about the ballooning federal debt, inflation, and how investors can protect themselves.

Over the last 20 years, the federal government's debt has grown faster than at any time since the end of World War II, running well ahead of economic growth. In addition to COVID-related spending, rising federal debt has been driven by longer-term trends including increasing Social Security and Medicare spending for an aging population. Today, according to the Congressional Budget Office, the federal debt is $22.5 trillion, more than 100% of gross domestic product (GDP).

Why debt matters

New Fidelity research suggests that higher debt can slow economic growth, and ultimately lead to higher inflation and more volatile financial markets. Warns Dirk Hofschire, senior vice president of asset allocation research: "Debt in the world's largest economies is fast becoming the most substantial risk in investing today."

In the short term, Fidelity's director of global macro Jurrien Timmer says a market consensus has emerged that inflation will rise in the second half of 2021: "An inflationary boom could result from the combination of COVID infections falling, vaccinations rising, ongoing massive fiscal stimulus, pent-up consumer demand, and low interest rates."

Longer term, Hofschire says, "The rise in debt is unsustainable. Historically, no country has perpetually increased its debt/GDP ratio. The highest levels of debt all topped out around 250% of GDP. Since 1900, 18 countries have hit a debt/GDP level of 100%, generally due to the need to pay for fighting world wars or extreme economic downturns such as the Great Depression. After hitting the 100% threshold, 10 countries reduced their debt, 7 increased it, and one kept its level of debt roughly the same."

Only time will tell which way the US goes and when. But Hofschire thinks "government policies are likely to drift toward more inflationary options." Among them:

  • Federal spending aimed at lower- and middle-income consumers
  • Increased public works spending not offset by higher taxes
  • Protectionist measures with a "made in America" rationale
  • Infrastructure upgrades targeting sectors such as renewable energy, 5G telecom, and health care
  • Higher inflation targeting by the Federal Reserve
  • Mandatory pay increases for workers benefiting from government assistance

In the longer term, if further free-spending fiscal policies are adopted while interest rates stay low and credit remains abundant, the likelihood of inflation could increase. But history suggests the magnitude and timing is uncertain. Many predicted an inflation surge the last time the federal government embarked on major fiscal and monetary stimulus after the global financial crisis, but inflation mostly failed to appear.

Some inflation hedges to explore

If you are concerned about inflation, you might want to consider diversifying your mix of stocks and bonds by adding investments that have historically benefited from higher inflation. Among them:

  • Treasury Inflation-Protected Securities (TIPS)
  • Commodities
  • Non-US stocks
  • Low-priced value stocks

If you want to create a plan with inflation in mind or want to refine your existing plan, try our online tools in the Planning & Guidance Center. Or for personal help, call a Fidelity professional.

Next steps to consider

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