Despite every commodity opening limit up virtually every day for the past two weeks on expectations of a free money tsunami about to be unleashed (and a 14th weekly increase in M2 which we will describe shortly), David Rosenberg still adheres to the belief that deflation is not only here to stay but get worse. And, frankly, we don't disagree. It has long been our contention that the sublimation from deflation to hyperinflation will not pass through the inflation phase at all (or it may, but will last for exactly one millisecond as $3 trillion, by then, excess reserves are released and send every price up by a few quadrillion percent). In the meantime, the input cost-price mechanism is still broken, which leads Rosie to believe that the fact that the 30 Year just closed at an increasing inflection point with the rest of the curve going tighter, is to be ignored. Alas, with corporate margins approaching zero (and if you are Amazon, probably already there) companies face one of three choices: become banks, and borrow at ZIRP, and lend money to their customers via private label credit cards (unlikely), shut down, or raise prices. The last one is what will happen, and will finally put an end to the ridiculous consumer disrectionary rally that has perplexed humans (but not robots) for quarters on end. Furthermore, as to Rosie claims: "For all the talk of how higher Chinese wages were going to be transmitted to higher prices of these imported items, it does not seem to be happening" we will shortly post some thoughts which confirm that this is precisely what is happening.
More on Rosie's denial:
DEFLATION RISKS INTACT
Despite a speculative equity market binge, a weakening U.S. dollar, an economy that seemingly avoided a double-dip recession last quarter, and a renewed boom in commodity prices, what continues to prove elusive in this illusory recovery is pricing power in the broad retail sector.
How apropos it was for Ben Bernanke to utter the word “deflation”, not once, but twice, in his Boston speech this morning. Because fifteen minutes later, the September consumer price index data were released and showed a goose-egg — that is 0% — on the key core CPI measure (which excludes food & energy), for the second month in a row. In the past, this has happened but 7% of the time, so it is a rare enough an event to at least mention.
The headline rate of inflation, despite everything that has been thrown at it in terms of unprecedented monetary, fiscal and bailout stimulus, sits at 1.1% today. The core rate, proven to be the key driver for bond yields, which is why it is a focal point, is now running at a mere 0.8% year-over-year rate, the lowest since March 1961 when Ben Bernanke was in grade school.
While QE1 may have worked in terms of bringing mortgage and corporate spreads out of orbit and preventing an all-out contraction in the money supply, it has not managed to stop the economy from sputtering, the unemployment rate from remaining near 10%, and underlying inflation from grinding lower. Consider for a moment that when the Fed first hinted at QE1 in December 2008, the jobless rate was 7.4% and the core inflation rate was 1.8%.
While commodity prices have been firming of late with the downdraft in the dollar, what is key is that we are seeing discernible deflationary trends evolve in many segments of the service sector. Movies, personal care services, hotels, delivery services, and education all deflated last month — education deflated at its fastest pace ever. This is no longer just about rents, which are now stabilizing.
Moreover, despite what the price of cotton is doing, clothing prices are still in decline, and other “goods” such as furniture, appliances, audio-video equipment, motor vehicles and home improvement all posted price declines last month as well.
For all the talk of how higher Chinese wages were going to be transmitted to higher prices of these imported items, it does not seem to be happening. Either that, or margins for several retailers are in the process of being crushed. The latest National Federation of Independent Business Sentiment Survey showed that company-pricing plans are virtually nonexistent. Therefore, it would make sense to assume that once we get pass this bump in the form of a weaker U.S. dollar and surging commodity prices, the risks of deflation will intensify again.
All the efforts to date have only managed to slow the pace of decline in consumer prices; they have not prevented core inflation from hitting four-decade lows. Right now, the long bond yield provides a 150 basis point premium over 10-year Treasury notes at the price of taking on nearly nine extra years of modified duration. Sounds like a handsome trade-off because even if the Fed is not targeting the 30-year maturity, a 3% real yield still looks fairly attractive from our lens.