Doubling Down on Deflationary Forces

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Almost all other forecasters have been looking for a revival of inflation for years. And they still are.

Zeal for Gold

After the Fed bailed Wall Street out of the 2008 financial crisis, and exploded its balance sheet through quantitative ease, many investors, including astute hedge fund managers, foresaw hyper-inflation and charged into gold as the most likely beneficiary. They solemnly quoted Milton Friedman, who said that inflation is driven by central bank-created money, and leaping Fed assets foretold lots more of it. But inflation didn’t gallop, but receded—and with it, gold prices.

But that hasn’t dissuaded the inflation bulls. Wall Street Journal columnist James Mackintosh wrote in the recent September 8 edition: “The danger is that the low inflation consensus has grown far too strong, on too little evidence.” A September 1 Journal headline sums up those folks’ problem: “Inflation Still Subdued, Posing a Conundrum.” They point to the low U.S. unemployment rate, the weak dollar, and stronger growth worldwide, which, they maintain, should intensify demand for commodities and push their prices up. Yet the personal consumption deflator, the Fed’s favorite inflation measure, ex food and energy has been slowing since late last year.

pce deflator

It rose just 0.1% in August for the fourth month in a row, pulling the year-over-year rise to 1.3% from 1.4% in July, 1.5% in June and 1.9% back in January. The Dallas Fed's trimmed-mean measure, which takes into account the price dispersion across a number of items, rose 1.6% in August from a year earlier. This is the slowest rate since December 2015, and it has been below 2% since April 2012.

As usual, the Fed has been right with the pack in forecasting too-high inflation and too-rapid economic growth. So, not surprising, the central bank has projected the federal funds rate it controls far above the rate it actually sets later. And the disruptions in energy supplies caused by Hurricane Harvey don’t appear to have long-lasting effects on prices.

Investors Disagree

At the same time, investors are much less convinced that inflation rates area bout to leap. Their expectations did jump before and immediately after the November 2016 election, but have since subsided, probably in part due to the recognition that Trump’s plans to rapidly reinvigorate the economy aren’t likely to happen any time soon.

It could be that investors’ and consumers’ expectations of future inflation simply reflect the current situation, and the two tend to move together. Still, comparisons of Treasury note yields with those on Treasury Inflation-Protected Securities reveal a forecast of declining inflation rates over the next 10 years. Also, a New York Federal Reserve Bank survey found that not only are consumers reducing their expectations of inflation, but their confidence in these views has strengthened, as shown by declines in their uncertainty.

Investors are also betting on low inflation for many more decades, up to 100 years. Bonds that don’t mature for a century were sold last year by the Irish and Belgian governments, and even problematic Argentina and volatile Mexico have issued 100-year bonds. So, in 2015, did French state-owned railroad company SNCF and power utility Electricité de France did so in 2014. In September, Austria followed its 70-year bond issued last year at a 5.3% yield with a century issue that investors lined up to buy despite a yield of only 2.1%. There were €11 billion in orders for the €3.5 billion issue.

100 year bonds

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