Albert Edwards of Societe Generale has just published his latest bearish message to his readers.
He warns of the “double threat of Chinese renminbi devaluation and complacent investor expectations.”
We’ll take a look at the latter.
“This week our preferred market-based measure of US core PCE (personal consumption expenditure) slumped well below the core PCE rate the market focuses on,” writes Edwards, who has long warned the U.S. is on the brink of all-out deflation.
He begins by relaying a message from the bond king Bill Gross:
Bill Gross at Pimco hit the nail on the head earlier this year when he said “I am amazed at the fascination and emphasis placed on the u-rate during employment Fridays. Bond prices will move (in some cases by points) with a minor up or down change in unemployment relative to expectations, but when it comes to the third pig in the litter — inflation — no one seems to care. This number — the PCE annualised inflation rate — is released near the 20th of each month, but you won’t see CNBC or Bloomberg analysts waiting with bated breath for its release. I do.”
PCE is the Federal Reserve’s preferred measure of inflation, and it’s been telling us the threat of inflation has been falling.
“In particular I have noted previously that the US Bureau of Economic Analysis (BEA) releases a “market based” measure of PCE,” he writes. “The BEA say “the market-based PCE is a supplemental measure that is based on household expenditures for which there are observable price measures. It excludes most imputed transactions (for example, financial services furnished without payment)”, i.e. it excludes prices which the statisticians have to invent!”
“Yet despite deflationary reality, 10y implied inflation expectations have not budged at all,” he continued. “Indeed on a 5y basis, implied inflation expectations seem to be drifting upwards! The gap between reality and expectations (or hope) just gets wider and wider!”
Deflation is a scary thing. When prices are falling, consumers are encouraged to wait for even lower prices. This often forces businesses to lower prices even further in their efforts to spur demand. Meanwhile, profit margins collapse, layoffs ensue, and the economy spirals.
On top of all that, the economic data has been disappointing.
“The US economic surprise indicator as calculated by Citigroup is seeing the weakest start to the year since 2008,” he noted. “Investors have decided to dismiss this weakness as wholly weather-related. The danger to the market is that as the weather improves the data does not, and both the equity and bond markets (viz inflation expectations) find themselves in totally the wrong place.”
Then again, if the economy is indeed improving, we’ll get the activity that ultimately leads to higher prices. Indeed, there are actually some strong anecdotal signs that inflation may already be picking up.