Monday, 23 July 2018

On Shrek and deflation

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Anthony Peters considers the Fed and how violent Lagarde’s economic ogre might be to markets.

There is always some senior Federal Reserve official in the news; the devolved structure of regional Presidents makes sure that there are plenty of voices making plenty of noise which can, from time to time, lead to conflicting and confusing opinions. No reason not to. Fed Presidents are not automatons with little tape players installed in their chests.

As recently as last week, we had the sharply conflicting views of the Minneapolis Fed chief, Narayana Kocherlakota, and those of the boss of the Kansas Fed, Esther George with respect to whether monetary policy should be more or less accommodative.

Into all of this mix we now find a speech given by the Chicago Fed President, Charles Evans, which possibly tops the lot in that it highlights just how difficult things are at the moment for policy making central bankers.

Evans was until last year a voting member of the FOMC and is generally regarded as being on the dovish side of the equation and I think that he has beautifully summed up the issues in the speech given, of all places, in Coralville, Iowa, wherever that might be. In it, he refers to the tapering move in December and comments that it doesn’t mean that the economy needed less accommodation but rather that the FOMC “agreed it was time to rebalance the mix” of policy.

“If inflation is the genie, then deflation is the ogre that must be fought decisively.”

He spoke of the “disappointing” December payroll report but did point out the job creation was still averaging 200,000 per month, adding however that forecasting the unemployment rate was “unusually tricky right now”. He then carried on to a subject that has us all perplexed, namely the persistently low level of inflation which he suggested “has not been good”.

Given the strength of the recovery and the persistently accommodative monetary policy environment, he referred to the inflation rate as “puzzling and worrisome”. He leaves no doubt in what he says that he can see no reason to tighten policy as long as there is still a QE programme in place, tapered or not, and inflation continues to undershoot target.

There is not much of his speech which I would not feel tempted to quote. It is a beautifully clear and well-crafted piece of writing and I would advise those with the time and the resources to give it a read. In its conclusion it simply states that US economic growth still faces “some important headwinds”.

I’m sure Mr Evans’ speech had nothing to do with the S&P 500 making new highs yesterday but new highs it made, closing at 1,848.38 points, having briefly broken above the magical 1,850 point level in intraday trading. We have come a long way from the 666.79 point low of March 6th, 2009 which marks an increase in the index of around 177½% for an annualised return of roughly 23%.

And yet we have a bucket load of central bankers – and not only central bankers – who are confused as to what is happening and why. Yes, the economy is rebounding nicely and jobs figures are improving, albeit with the odd hiccup, but there remains the inflation conundrum.

The ECB is clearly concerned with the risk of deflation and now the IMF boss, Christine Lagarde, has joined the chorus with a stark warning that unless advanced economies did more to fight the threat of deflation, the currently “feeble” global recovery would be at risk of faltering. Global growth is still falling short of potential and although there are clear signs that it is picking up, albeit gently, wrong policy decisions could endanger this tender plant. “If inflation is the genie, then deflation is the ogre that must be fought decisively,” she said.

I never thought I’d live to see a bevy of central bankers calling for more inflation rather than less and to see the deflation debate being carried out in public at the same time as stock markets are making one all time high after the other has me foxed as much as the next man.

Are markets doing what they are best at, namely only looking at the data which confirm the direction in which they are going, or are they ahead of an over-cautious and fearful central banking community? It’s hard to believe that we have achieved Nirvana in the form of a NICE economy (non-inflationary consistently expansionary) and if we have, why are the authorities so scared of it?

The answer is simple. Last time round it was made of smoke and mirrors and they are now evidently concerned that they will of a sudden be hit by  another corpse falling out of the wardrobe.

I am myself not immediately fearful of the continuing rally in risk asset prices but I am cautious when it comes to investors treating them as nigh-on risk-free. Not even tigers are dangerous if they are kept in a secure area and looked on from a distance. If they are treated as though they are just large pussy cats, someone will end up being eaten for lunch. Simple.


Alas, for me it is that time of the week again as I shall be out in the flooded English countryside on Friday. All that remains is for me to wish you and yours a happy and peaceful week-end ahead. The Christmas thing is out of the way, the bank accounts are empty, the January pay-cheque hasn’t arrived yet, the kids are back at school, there is nothing to do in the garden, it’s too cold to wash the car… How about lighting a fire and having a nice glass of wine and a little snooze in front of the telly while watching some skiing or rugby?Job done! 42 Celsius is Melbourne……nah!                  

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