“>http://commons.wikimedia.org/wiki/File:Oil_well.jpgCommodities have had a bad year, and they’ve been really ugly over the last few weeks.
The response has been: ‘Uh-oh, deflation!’
Added together with the weak data out of Europe, China, and the US, the decline in commodities looks like demand is slackening yet again.
Yet maybe that’s not it.
In his weekly ‘Sunday Start’ letter, Morgan Stanley’s Joachim Fels presents the other side of the commodity collapse, and a reason to be optimistic:
Somehow the proverbial American optimism must have affected me also when it comes to the cyclical outlook. What I’ve been telling investors on my trip is that despite the soft patch in the US economic data, the wobbly recovery in China and what looks like a deepening recession in the euro area following this past week’s PMI, Ifo and INSEE business surveys, my confidence in our ‘twilight to daylight’ saga of a second-half global rebound is actually even stronger now. Why? One reason is the much-discussed drop in commodity prices. My sense is that this is not just a reflection of recently weaker global growth data. I rather suspect it is also due to the supply response in many commodity markets that has been elicited by years and years of elevated prices, and to a growing realisation by investors that global money-printing does not necessarily lead to high inflation, which has probably reduced the demand for commodities such as gold and oil as inflation hedges. In any case, lower commodity prices lead to what I call ‘good disinflation’ as consumers’ real disposable incomes benefit from lower energy and food prices. Hence, I expect the global soft patch to give way to a consumer-led re-acceleration in the next couple of months.
The second half of the explanation, that there’s been a sea-change in thinking among investors about the relationship between “money printing” and high inflation is an important one.
We’ve seen the gold bugs and Fed haters go from saying that hyperinflation is right around the corner to saying that the Fed is incapable of engendering inflation, even when it wants to. Take famous gold bull Jim Rickards.
It’s a sad day when a central bank really wants inflation and can’t make it happen on.wsj.com/12FSxa1. Price projectile dysfunction.
— Jim Rickards (@JamesGRickards) April 29, 2013
Beyond this benign deflation, Fels sees another reason to be optimistic about the economy, which is the re-revving up of monetary stimulus:
Another reason to get more upbeat on the cycle is monetary policy. The Bank of Japan’s regime change, the economic soft patch, and the global retreat of inflation have already led to more dovish noises from many central banks in recent weeks. We’ll see whether the statement following this coming Wednesday’s FOMC meeting already drops some hints, but my conversations in Washington the other week suggest that US policy makers have taken note of the recent decline in US inflation, which was underscored by the easing of the core PCE deflator to 1.3% in 1Q in Friday’s GDP data. Undesirable disinflation, along with a continuing miss on the second part of the Fed’s dual mandate (note we expect the unemployment rate to remain unchanged at 7.6% in Friday’s labour market report) is likely to make the talk about tapering off QE taper off.
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