Is Inflation an issue or did the Fed Mess Up?
The Fed has been trying to create the illusion that inflation is an issue. The guys from the hard money camp also maintain that inflation is an issue and to a point they are right. Their definition of inflation is an increase in the money supply. The Fed, on the other hand, defines inflation as an increase in prices. The real definition of inflation is an increase in the money supply; rising prices are just the symptom of the disease. This article from mises.org summarises this concept quite succulently
We are not going to spend time dwelling on this point as the crowd has bought the line the Fed has sold them and so the above point is moot. This article will focus on the price factor and not money Supply factor.
In numerous articles published over the last twenty months, we stated that Fed would be playing with fire if they raised interest rates as this economic recovery is based on “hot money”. We went on to state that if they raised rates, it would be a temporary ploy to buy them more wiggle room. Yellen recently confirmed that the Fed’s Hawkish bias might be coming to an end. She acknowledged that Inflation was below the Central bank’s target of 2%
Yellen, as she has in other statements recently, told lawmakers that she expects low inflation to be transitory. "Temporary factors appear to be at work. It's premature to reach the judgment that we're not on the path to 2% inflation over the next couple of years,” Yellen said. "As we indicate in our statement, it's something we're watching very closely, considering risks around the inflation outlook.” Full Story
Based on the factors we are going to list below, Yellen, might have to wait a very long time before inflation hits the Fed’s target rate of 2%. All we need to do is look at Japan; they have been trying to generate inflationary forces for decades without any success. They continue to inject billions into the economy hoping for change, but inflation remains stubbornly low. Our economic recovery is not real; remove the easy supply of money, and the economy will collapse.
Former Bond King Bill Gross seems to concur:
In inflation was an issue, central bankers worldwide would be raising rates; instead, we find that many of them are lowering rates.
BOJ stated that they had no intention of raising rates in the near future
South Africa’s Central banker’s surprise markets with a Rate cut
Inflation appears to be decreasing on worldwide basis
Even though Canada raised rates, the data indicated that a rate increase was not warranted. The July rate increase might be a short lived stint. They might mimic the Fed’s footsteps and then back away.
According to FT, Inflation in Germany (Europe’s largest economy) fell to 1.4%; a low for 2017
Brazil’s inflation falls to a decade low
Credit Suisse goes on to state that Global inflation risks remain low in the following article
Why are these central bankers not running out and raising rates? These countries cannot play with fire; their currency is not the World’s reserve currency, so they have limited room to manoeuvre. They are not going to risk a recession when they are fully aware this economic recovery is an illusion. Remove the cash infusions, and the economies of the world will collapse.
Take a look at the US retail sector; the entire sector is imploding due to players like Amazon that continue to push prices lower and lower. Bloomberg estimates that 8640 stores are set to close by year end. We think this estimate might be conservative and that the final tally could be north of 9,000.
With Amazon’s purchase of Whole Foods and Lidel’s entry into the US market, a massive grocery war is underway; this price war will trigger another set of deflationary forces. Lidl has stated that they would price groceries up to 50% below US rivals.
Aldi the other German company that has been here for some time already offers prices that are below Wal-Mart’s prices; the upside here is that the consumer gets good priced lower than those at Wal-Mart, but the quality is far superior. Analysts estimate that by 2020 Lidl will have over 300 stores in the US. Aldi already has 1600 stores in over 35 states plans to open another 900 stores within the next five years. Aldi and Lidl are a formidable duo; they have already sent shockwaves through Britain's Grocery Retail Market, hurting old timers such as Tesco Plc and the ASDA Supermarket chain.
Artificial Intelligence (AI) and Technological breakthroughs will continue to drive prices lower. Look at how much pricing power the consumer has today compared to a decade ago; this trend will continue to gain traction.
There is another factor “ the velocity of M2 money stock” it indicates that inflation is not an issue. The velocity of M2 money stock in the US has been plunging for years and shows no signs of letting up; if inflation were an issue the velocity of M2 would be trending upwards and not downwards. We will examine this in more detail in a follow-up article.
The Bond market does not buy the inflation argument
We tend to focus more on the technical and psychological outlook, and both are indicating that inflation is still not an issue. The Gold market is also indicating that inflation is not an issue. Last July Gold traded past $1400; at that time rates were lower and the US dollar was trading at higher levels. But today rates are higher today, and the dollar is trading lower than it was in 2016, but Gold instead trading at or above $1400 can’t even trade above $1300 for sustained period.
The psychological factor does not support higher prices; the economy is not doing well as the consumer is not spending wildly. Consumer confidence is increasing, but consumer spending is not marching in tandem with consumer confidence. Income growth is weak; the rise in incomes and net worth has primarily benefited high income and high net worth households. These are the same individuals that have the most money invested in the stock market which has tripled since its March 2009 lows.
We have listed a plethora of factors that illustrate that inflation is not an issue; at least not yet.
Even James Bullard, president of the Federal Reserve of St Louis went seems to be in agreement
“Low inflation has been the major surprise of the era,”
He also went on to state that he was still waiting for inflation to return to the 2% ranges and would not support any increases in the Fed’s benchmark rate until 2018 to allow inflationary forces to recover. He might have to wait a lot longer than that. AI and technology, in general, are going to continue to fuel lower prices. The retail sector is in freefall; the remaining players battle it out, and price wars will continue for the foreseeable future. Food prices are going to plunge due to the price war that new entrants like Lidl and Amazon have triggered.
The bond market is not supporting the higher inflationary outlook, in fact by all measures the bond market appears to be building momentum to trend higher.
By Sol Palha
Send this article to a friend: