Deflation – Don’t Bet on It.
Expecting deflation to take hold is essentially betting against the combined power of the MPC, BoE and Government and the efforts of their counterparts in the US and elsewhere to prevent deflation. Ultimately they control the printing presses and given that we are not shackled to a Gold Standard (and neither Sterling nor the Dollar are in a fixed currency bloc) and the authorities are well aware of the deflation risk then it seems unwise to bet against them.
Low bond yields are not necessarily predicting deflation but could just be the result of expecting interest rates to remain at very low levels for several years (which does not appear an unreasonable expectation at the moment).
Ben Bernanke wrote the book “Essays on the Great Depression” about the 1930s and gave a speech in 2002 about the Japanese experience of the 1990s. His speech was entitled “Deflation - Making Sure it Doesn’t Happen Here” (see prior blog post of 3 Nov 2008 entitled “Get Me a Printing Press”). So Ben is well aware of the risks of deflation and as the US Dollar floats freely then we can bet he will have the printing presses rolling day & night if necessary to avoid deflation as the Fed spends the money it prints on buying US Treasuries, corporate debt & asset-backed bonds to keep credit flowing.
The US stockmarket rallied once again last Friday (6 Feb) as the monthly employment report showed another 600,000 jobs had been lost in January. The FT’s Lex column showed total disrepect for the market by claiming this was a “la-la” reaction by the market as it ignored a terrible piece of economic data. Lex appears to have forgotten the concept of a market being able to price in the bad news ahead of its publication. The unemployment rate is now 7.6% whereas many economists are expecting unemployment to rise to 9% before this recession ends. Given that the market has now rallied after the publication of each of the last two monthly employment reports it seems fair to assume that the market’s focus of attention is elsewhere – perhaps upon the Obama stimulus plan and what Q1 earnings are going to look like (we will find out the latter during the April reporting season).
The reality is that markets have been in a wide trading range since the November lows last year. This is clearly a consolidation pattern and there are only two outcomes: Either the markets are building a broad base here before eventually breaking higher or those expecting the Dow to go to 5,000/6,000 are right and we are going to break lower and the bear market has not ended yet. The sensible course of action is to raise some cash if markets rally to the top of their trading ranges before the G20 London summit at the start of April (billed as the world coming together to fix the credit markets), and the Q1 earnings season which will follow during April. But with the world’s governments & central banks focused on preventing deflation, it is not likely to take hold.
Tags: bear market, ben bernanke, boe, bond yields, corporate debt, deflation, disrepect, employment reports, gold standard, Great Depression, lex column, MPC, printing presses, trading range, Treasuries