“Stock and bond markets have been sending out disinflationary signals.”
— The Wall Street Journal, Oct. 9
After a sharp recovery this spring following the late 2018 selloff, markets drifted looking for economic clues to clarify the outlook. The signals have been mixed.
U.S. employment data and consumer spending (which makes up more than two-thirds of our economy) continue to be strong. Yet, U.S. manufacturing data continues to slow, alongside global industrial production data that look bleak.
Surveys of CEO confidence are the lowest they have been since 2009, and sit at levels that typically correspond to recessions. The growth in corporate earnings have also slowed apace the negative sentiment and the escalation of trade war tensions.
All this has caused a sharp reversal of growth forecasts and inflation expectations. In fact, deflation fears are on the rise again.
Central banks have historically spent their time trying to rein in high rates of inflation. Take a look at the humanitarian crisis in Venezuela and we can all agree hyperinflation creates chaos and social disaster.
Central banks instead prefer low, consistent inflation — with 2% the prescribed remedy. This allows governments to steadily spend a bit more than they take in and inflate away the delta.
The inflation is low enough to keep the system from catapulting toward chaos, but pervasive enough to eat away at your purchasing power over time.
But ever since the financial crisis a decade ago, central bankers have worried more about the risks of deflation than inflation. Deflation means the debts incurred now are more expensive in the future, which incentivizes people to save more.
Saving more means less spending, which means less growth, which means lower employment, which means economic pain, which means political unrest, which means trouble.
Many of you may have grown up during times of inflation, but today’s central banker is trying to stave off deflation with every last breath. They are actually trying to create inflation.
Now, we have more than $17 trillion of debt floating around the planet with negative yields. That’s right. You loan someone money, and get paid less that you loaned them, on purpose.
Greece, the fiscally-insane problem child of the Eurozone, which was on fire (actually) a few years ago because it could not pay its debts, entered the negative interest club last week.
A year ago, the Federal Reserve was in “tightening” mode. It let half a trillion dollars of its balance sheet roll off.
(What does that mean? During the financial crisis, the Fed printed money to buy bonds in an effort to lower interest rates. The thinking was if debt was cheap, we would all borrow more, and spend ourselves out of the recession. To some degree it worked, so last year the Fed began to unwind that funny money.)
This drained some cash, some “liquidity,” from the system. In parallel, the Federal Reserve hiked short-term interest rates four times last year, making it a bit more expensive to have all that debt we accumulated. This slowed the economy down.
Then the trade wars escalated, and uncertainty rose. Companies hate to invest when the political and economic frameworks for businesses are turned upside down. Dealing with the ebb and flow of customer buying behaviors is one thing; having entire legal frameworks torn up by a tweet is another.
So, after tightening dramatically in 2018 the Fed has reversed course, cutting rates twice in 2019 with market expectations for more to come. Over the last 18 months, the tilt toward “inflation is coming, we better get ahead of it” has flipped 180 degrees to “we must combat deflation at all costs.”
A Citibank long-short index of companies that do well vs. poorly in inflationary times is down nearly 40% over the last year. If your portfolio was positioned to “win” in inflationary times, it’s been a miserable year. Is it time to reconsider?
The most recent government data for producer prices and consumer prices were released last week. The headline numbers were a bit softer than the market was expecting, which bolstered bets the Federal Reserve would cut short-term rates again this month. As of late last week, the market was placing roughly an 80% probability the Fed will cut in another 0.25%.
Even so, digging into the numbers, we find year-over-year change to the core Consumer Price Index (CPI) rose 2.4%, above the Fed’s stated goal of 2%. The median CPI hit 3% for the first time in over a decade.
Central bankers are trying so hard to create inflation. They may soon get their wish.