Tuesday, October 3, 2017

Global Inflation in Freefall?

Ann Saphir of Reuters reports, Fed's rate hikes causing low inflation, Kashkari says:
The Federal Reserve’s own actions, not transitory factors, are responsible for weak inflation, a Fed policymaker argued on Monday, and the U.S. central bank should wait to raise rates again until inflation hits its 2-percent goal.

“The FOMC’s policy to remove monetary accommodation over the past few years is likely an important factor driving inflation expectations lower,” Minneapolis Fed President Neel Kashkari wrote in an essay on the bank’s website, referring to the central bank’s Federal Open Market Committee, which sets U.S. interest rates. “My preference would be not to raise rates again until we actually hit 2 percent core PCE inflation on a 12-month basis, unless we have seen a large drop in the headline unemployment rate signaling that we have used up remaining labor market slack, or a surprise increase in inflation expectations.”

Kashkari’s comments stake out a dovish view of policy at odds with that of the Fed’s core, who expect inflation to strengthen as the labor market tightens. Most Fed policymakers, including Fed Chair Janet Yellen, expect they will need to raise rates in December, and three more times next year, to keep the economy from overheating.

Kashkari, who dissented twice this year against Fed rate hikes, argued Monday that the Fed’s decision to end bond-buying in 2014, its hawkish guidance on rate hikes since then, and the four rate hikes it has actually completed have pushed inflation expectations down and kept job and wage growth slower than they would have been otherwise.

Allowing inflation expectations to slip gives the Fed less leeway to fight future downturns with rate cuts, he said.

“There is no reason to raise rates until we start to see wages and inflation climb back to target,” Kashkari wrote. “The only explanation that would potentially call for further policy tightening is the transitory factor explanation. But the longer low inflation persists (here and around the world), the more tenuous that story becomes.”

The Fed should therefore “proceed with caution” on raising rates further, he said.
You should all take the time to read Neel Kashkari's take on inflation here. I note the following passage on four rate hikes :
The FOMC began actually raising the FFR in December 2015 and followed up with three more hikes through June 2017, despite muted wage and inflationary pressures. The signal from this activity suggests a strong desire to raise rates, even with an absence of inflationary pressures.

We know that monetary policy operates with a lag. I believe these actions to remove various forms of accommodation are now having an effect on the economy by lowering inflation expectations. In my view, inflation expectations declined because actual inflation was below target for a long time, and the Fed’s actions to reduce accommodation led to a weakening of confidence that it was serious about bringing inflation back to target in a reasonable time frame.
Kashkari isn't the only dove on the Fed warning against rate hikes in the absence of inflation. Last week, Reuters reported, Fed needs to see prices rise before next rate hike, Evans says:
The Federal Reserve should wait until there are clear signs that American paychecks and prices are rising before raising interest rates again, a U.S. central banker said Monday, warning that moving too fast would be a policy “misstep.”

Chicago Federal Reserve Bank President Charles Evans, who votes this year on monetary policy, said he broadly agrees with his colleagues who believe rates should rise gradually to about 2.7 percent over the next two years or so, from the current range of between 1 percent and 1.25 percent.

But he said inflation, running at 1.4 percent by the Fed’s preferred gauge, is too low, and voiced concerns that low inflation expectations will keep it from rising toward the Fed’s 2-percent inflation goal.

“We need to see clear signs of building wage and price pressures before taking the next step in removing accommodation,” Chicago Federal Reserve Bank President Charles Evans said in remarks prepared for delivery to the Economic Club of Grand Rapids. “A gradual and cautious approach continues to be the appropriate strategy.”

His comments stood in stark contrast to the confident tone adopted by William Dudley, chief of the New York Fed, who earlier Monday said inflation weakness is fading.

The Fed has raised interest rates twice this year, and last week policymakers pointed to one more rate hike this year and three next year. Fed Chair Janet Yellen said such increases are justified by improvements in the labor market and the conviction that inflation will return to 2 percent by 2019.

Evans said he is less optimistic about inflation. Returning inflation to 2-percent over the medium term, he said, calls for policies that generate at least the possibility inflation could exceed 2 percent.

“We should avoid taking policy steps that could be misread as a lack of concern over the inflation outlook,” said Evans. “In my view, that would be a policy misstep that would further delay achieving our inflation objective.”
I happen to agree with Evans and Kashkari who are taking over former Minneapolis Fed president, Narayana Kocherlakota, in terms of sounding the alarm on the lack of inflation.

It doesn't really matter because Janet in Wonderland and William Dudley think the (lack of) inflation is "transitory" and it's only a matter of time before inflation rears its ugly head once again.

Or maybe not. Maybe they too fear deflation is headed for the US, and now is the time to "store up ammunition", get off the zero-bound, and prepare for the next global financial crisis and help big US banks shore up their balance sheet before the big deflation tsunami swamps the US and it's game over for a decade or longer.

Some think they are doing the right thing, preparing for Trump's big tax cuts and infrastructure spending program which are inflationary (if you want to talk transitory, that's the first place to go).

Over in Europe, ECB executive board member Peter Praet was speaking in London stating deflation has disappeared but inflation isn't high enough:
Inflation in the eurozone hasn’t yet reached the European Central Bank’s definition of price stability and the path toward this goal will shape the ECB’s plan to end its bond-buying program, the central bank’s chief economist said Monday.

Peter Praet said the ECB remained confident that inflation would ultimately hit levels that were close to, but below, 2%, the ECB’s medium-term price stability target.

But “the evidence still shows insufficient progress toward a sustained adjustment in the path of inflation toward those levels,” Mr. Praet said in remarks in London and published on the ECB’s website.

Data released last week showed inflation in the eurozone was 1.5% on the year in September, lower than economists’ expectations. Moreover there was evidence that price pressures could be easing. Core inflation, which excludes prices of energy and food that the ECB has little influence over, stood 1.1%, its lowest level since June.

The reading for September may mark a peak for many months to come. That is because oil and food prices rose rapidly in the early months of this year, but have since moderated. Indeed, the ECB has warned that inflation is likely to dip below 1% at the start of next year, when it is likely to start to cut back on its bond buys.

Mr. Praet’s comments may suggest that the central bank is likely to be exceedingly cautious as it ends its bond purchase program. Markets expect the ECB to offer more detail on these plans at its meeting on Oct. 26th. The ECB currently buys €60 billion in bonds per month and is due to continue purchasing at that volume until the end of the year.

But investors are eyeing the October ECB meeting for clues about an expected gradual reduction in purchases next year.

“Such “sustained adjustment” is the principal contingency that has guided and will be guiding the introduction and withdrawal of our asset purchase program (APP) and, indirectly, of all the main components of our present policy,” he said.
As you can see, it's not only the Fed making a huge mistake removing stimulus, the ECB is also contemplating making the same mistake.

In Japan, the Bank of Japan tankan corporate inflation expectations is flagging:
Japanese companies' inflation expectations eased slightly in September from three months ago in a worrying sign the economy continues to struggle with a deflationary mindset.

Companies surveyed by the Bank of Japan expect consumer prices to rise 0.7 percent a year from now, lower than their projection for a 0.8 percent increase three months ago.

Firms also expect consumer prices to rise an annual 1.1 percent three years from now, unchanged from the previous survey.

Japan's economy has grown at a healthy pace this year, but consumer prices have eked out only small gains, which could hasten calls for the BOJ to either expand monetary easing or overhaul its approach to reflating the economy.

"Companies are more optimistic about overseas economies and don't expect domestic retail prices to rise that much," said Shuji Tonouchi, senior market economist at Mitsubishi UFJ Morgan Stanley Securities.

"We won't see an immediate change in the BOJ's policy, but this does show that monetary easing will have to remain in place for a long time."

The data come one day after the BOJ's tankan survey on corporate sentiment showed big manufactures are the most confident in a decade as global demand adds momentum to the economic recovery.

The tankan survey also showed companies expect the economy to lose a little momentum in the next three months.

Core consumer prices, which include oil products but excludes fresh food prices, rose 0.7 percent in August from a year earlier, marking the eighth straight month of gains but still well below the BOJ's 2 percent inflation target.

One BOJ policymaker called for expanding monetary stimulus at a policy meeting in September, raising concerns that the board could become divided.

The central bank next meets on Oct. 30-31, where it will update its forecasts for consumer prices. A lowering of the forecasts would put pressure on the central bank to take further steps.

The BOJ started the survey on corporate price expectations from the tankan in March 2014 to gather more information on inflation expectations, key to its current stimulus programme.
The Economist notes the Bank of Japan is sticking to its guns:
Seventh time lucky? Minutes of the Bank of Japan’s (BoJ) policy meeting in July, published on September 26th, showed that the central bank had, for the sixth time since 2013, pushed back the date at which it expected prices to meet its 2% inflation target—to the fiscal year ending in March 2020.

Four-and-a-half years since Haruhiko Kuroda took office as governor and embarked on an unprecedented experiment in quantitative easing (QE), the bank is still far from its goal. It has swept up 40% of Japanese government bonds and a whopping 71% of exchange-traded funds. The bank’s balance-sheet has tripled. It is now roughly the size of the American Federal Reserve’s.

Yet, despite his apparent failure, and despite a snap general election, Mr Kuroda may yet stay for another five years when his term runs out next April. If not, most of his likely successors are signed up to the same reflationary policy. At least one member of the bank’s board gave warning at its most recent policy meeting on September 20th-21st that the measures it has taken are insufficient to stoke the desired inflation. These include keeping short-term interest rates negative, at about -0.1%, and ten-year government-bond yields at around zero. Soon, however, debate might turn to the feasibility of the 2% target.

Many countries would be happy to have Japan’s problems, says Masamichi Adachi of JPMorgan Securities: full employment, soaring corporate profits and the third-longest economic expansion since the second world war. But with government reforms faltering, the BoJ’s role as custodian of “Abenomics” (the policies of the prime minister, Shinzo Abe), seems assured. A labour crunch may at last be working where government badgering of Japanese companies to pay workers more has failed. In a speech this week, Mr. Kuroda pointed to rising wages as a reason to hope inflation will pick up. Firms, he said, have been absorbing the cost to keep prices low, but will not be able to do so forever.

Not all share his optimism. Monetary easing is failing in one of its aims, says Sayuri Shirai, a former BoJ board member: to foster risk-taking corporate behaviour. Instead, the amount of cash hoarded by Japan’s companies has grown by about ¥50trn ($443bn) over the past five years and exceeds ¥210trn, a record.

With sluggish investment and demand, Mr Kuroda’s monetary blitzkrieg will continue. The risk, says Ms Shirai, is that monetary policy has become a crutch for the entire economy. Leaning on the central bank, some companies are reducing efforts to boost productivity and improve governance, she says. And, by becoming the largest shareholder in several companies, the bank is distorting the pricing function of the market, adds Nicholas Benes, of the Board Director Training Institute of Japan.

Mr Kuroda stunned the markets with QE in 2013 and has continued to surprise since with a string of policy innovations. But nobody, says Mr Adachi, can see when the BoJ will start to reduce its asset purchases, let alone trim its balance-sheet. Perhaps never. For all the problems its easy-money policy brings, many think it more costly to ditch it than to keep on digging.
It's important to keep an eye on Japan because that's where I believe we're headed. One thing is for sure, low inflation could put central bankers' superhero status at risk.

Meanwhile, the global retirement reality is still lurking out there, and threatens to impoverish hundreds of millions of retirees who will end up succumbing to pension poverty, retiring with little to no savings.

Don't kid yourselves, the $400 trillion pension time bomb isn't going away and whatever policies are enacted to address it, it's deflationary.

In my last comment on the global retirement reality, I ended by disagreeing with David Stockman who thinks rates are headed much higher for the simple reason that deflation in Asia + deflation in Europe doesn't equal inflation in the US.

Stockman might turn out to be right on a major correction in stocks but he doesn't understand the transmission mechanism this time will be debt deflation, soaring unemployment, and much lower interest rates as far as the eye can see.

Importantly, US inflation expectations slipped last month, with the year-ahead measure hitting its lowest level since early 2016, according to a Federal Reserve Bank of New York survey that adds to the din of surprisingly weak price measures:
The survey of consumer expectations, an increasingly valuable gauge as the Fed decides when to raise interest rates again, slumped despite predictions among respondents for a rise in gasoline prices.

The New York Fed report showed that one-year-ahead inflation expectations were 2.49 percent in August, down from 2.54 percent in July, marking the weakest reading since January 2016. The three-year measure ticked down to 2.62 percent, from 2.71 percent a month earlier.

Both measures have generally declined since the survey began in mid-2013, reflecting the years in which most U.S. inflation measures have fallen short of the central bank’s target. If the weakness persists, the Fed, which hiked rates twice this year, may put off its plans for another policy tightening by December.

Respondents - who were generally surveyed before Hurricane Harvey hit Texas in late August - expected gas prices to rise by 4.1 percent a year from now, up from 3.0 percent a month earlier.

The internet-based survey is done by a third party and taps a rotating panel of about 1,200 household heads.
And keep in mind, the drop in US inflation expectations persists despite the decline in the US dollar (UUP) since the beginning of the year. With the greenback set to reverse course, you can expect a decline in US import prices and lower inflation expectations going forward.

All this reinforces my main macro thesis that global deflation is headed for the US and we need to prepare for worst bear market ever.

I know big tax cuts and spending on infrastructure are in the works, the Fed needs to worry about fiscal expansion but I'm worried it's making a huge mistake, one that will come back to haunt us all.

Maybe I'm too bearish and should just listen to Warren Buffett who was on CNBC this morning stating once again he's baffled at who would buy a 30-year bond and that low rates augur well for stocks for the long run and they pay no attention to the Fed (see clip below).

Buffett also said they are holding off selling investments to see how the GOP tax reform plan shakes out and the anticipation of tax cuts means billions of investor dollars are doing the same thing, which also explains why stocks keep rising.

"We may or may not have a change in the tax code," Warren Buffett tells CNBC. "Right now we're sitting and watching because within three months, actually less than that, we'll know the answer on it."

Below, Warren Buffett, Berkshire Hathaway chairman and CEO, speaks with CNBC's Becky Quick about his outlook on markets, tax reform and his new investment in Pilot Flying J.

I hope the Oracle of Omaha is right because with global inflation in freefall, it's only a matter of time before stocks go into a freefall and the yield on US long bonds hits a new secular low, propelling long bond prices (TLT) to new highs. Be careful out there, especially if you don't have Buffett's deep pockets and long investment horizon, you will get crushed.

Lastly, I was saddened to learn that rock legend Tom Petty died Monday at age 66 after suffering a massive heart attack. Below, one of my favorites from Petty, fitting for this blog comment.



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