"I Was Wrong": Albert Edwards Finds Something That Has Never Happened Before

At the start of the year, we were surprised when SocGen's Albert "Ice Age" Edwards, the biggest perma-deflationist on Wall Street, flipped his outlook on the US economy, and said he now expected a fast spike in inflation driven by wage growth, which in turn would prompt an even more accelerated tightening cycle by the Fed. We did not see it, and said so, pointing out that the bulk of US job growth in recent years has been among industries that have little to no wage power. More than half a year later, and several months after a puzzled Edwards asked "Where Is The Wage Inflation?", the SocGen strategist has finally thrown in the towel, and in a note released this morning, admits he was wrong, or as he puts it "I was too optimistic", to wit:

At this point in the US economic cycle a tight labour market would normally be producing a notable upturn in wage and CPI inflation. This would usually prompt the Fed into a tightening cycle that would typically end in a surprise recession. This is exactly what I expected to occur at the start of this year and I thought it would be that recession that would tip the US into outright deflation ? but I was wrong. I was too optimistic!

And while there has been a modest improvement in average hourly earnings according to the BLS, if not according to the BEA's wage data, which according to the just released Personal Income data showed another drop in both private and government worker wages...

... broader inflation trends continue to disappoint.

Furthermore, when digging through the recent CPI data, Edwards noticed something unexpected: as he writes, although wages have accelerated due to the tight labor market, the last six months has seen consistent downside surprises. And then this: "this has come hand-in-hand with an unprecedented slump in underlying US CPI inflation into outright deflation - in stark contrast to the eurozone where core CPI inflation has decisively risen."

Putting the finding in context, the "wrong, too optimistic" Edwards writes that never since the mid-1960s, when records began, has core CPI (less food, energy and shelter) declined over a six-month period, as demonstrated by the red line in the chart below.

Or, as he summarizes, "Deflation did not need another US recession to emerge. It is already here."

Next, Edwards lays out why he - like so many others - were fooled into believing the reflation trade (think Trump) had arrived, and why it is all over now:

The reflation trades that surged in the second half of last year have struggled this year. As far as the bond market is concerned, the jump in 10y implied inflation expectations has unwound most in Japan and the US, while remaining resilient in most of Europe (see chart below).


The market?s changing inflation expectation has been driven by diverging actual inflation performances, especially at the core CPI level. US core CPI has been particularly weak.


It's not just the Trump effect however: even more important is the recent downward inflection point in rent and shelter inflation, arguably the biggest surprise in upcoming CPI prints; unless the shelter inflation decline is stemmed, soon core CPI will be at level that may prompt the Fed into easing more.

Shelter dominates US CPI at over one-third of the total in a way it does not elsewhere. In the eurozone, for example, it comprises only some 7% of total CPI (predominantly rent). Excluding the dominant impact of shelter from US CPI reveals a shocking slump into outright deflation over the last six months ? the first since records began.

In the above chart we have removed from traditional core CPI (ie excl. food and energy), the entire dominant 34% shelter component of CPI. Instead of removing all of the 34% shelter, we can just remove the quirky (made-up) Owner Equivalent Rent (OER) sub-component (which comprises 26% of total CPI). This leaves just the rent component of shelter (8% of CPI), putting the US on an equivalent basis to the eurozone.  Excluding just OER, core US CPI has also slumped. On a six-month basis core US CPI (less OER) is slightly stronger than it is excluding all of shelter, but it has still slumped to an unprecedented zero (see left-hand chart below).

As Edwards then points out, while the Fed?s preferred measure of inflation, the core PCE (Personal Consumption Expenditure) deflator, has also slid back recently to 1.5% yoy, if you look at the market-based measure of core PCE which excludes ?imputed? items, core PCE is only running at 1.2% yoy ("see righthand chart above, and as Edwards clears up, "btw ?imputed? items are commonly known in plain English as ?made-up? numbers, just as the OER is in the CPI data").

Here the SocGen strategist has some advice to the Fed:

If I were a Fed Governor I would be pretty shocked/concerned/bemused at inflation developments this year. However confident the Fed is of a self-sustaining-recovery, there is growing evidence of a slide into outright deflation even ahead of the next recession which will likely unambiguously take us deep into deflationary territory.

 Imminent deflationary prints notwithstanding, Edwards still thinks rates should be normalised. Why? "Well, because the longer the current credit excesses are allowed to continue, the deeper the next recession and deflationary bust will ultimately be."

Which brings us to Edwards' always somber, if comprehensive, conclusion, first for the economy and Treasurys:

Our Ice Age thesis has always called for US and European 10 year bond yields to converge with Japan. We still expect that to happen, with the downward crash in US yields likely to be particularly shocking. There is mounting evidence that underlying US CPI inflation has already slid into outright deflation in exactly the same way that Japan did seven years after its credit bubble burst. Hence we repeat our call for US 10y bond yields to ultimately converge with Japan and Germany at around minus 1%.

As for equities...

We are currently stuck in yet another lower high for nominal quantities. Investors should now be preparing for the next deflationary lower low in nominal GDP and what that implies for asset prices. It won?t be pretty.

Although to be honest, we've heard it all before, and while Edwards is spot on accurate, his conclusion makes one sweeping assumption: that central banks will abdicate their duty to keep asset prices propped up. If there is one lesson to tbe gleaned from the past decade is that just when it appears that the bottom is about to fall out of capital markets, central banks step in with an even more powerful intervention to keep the charade going just a little bit longer. It remains to be seen if this time will be any different...


fx Stuck on Zero Fri, 09/01/2017 - 03:41 Permalink

I love the writings of Edwards, but for once, the US CPI has at least a much more realistic representation of rent in the overall CPI. Over here in Europe (and from what I heave read, heard and seen in the US, too) the normal middle-low income household (95 % of the people) spends 20-40 % per month on housing (mostly rent). So why on earth does the single most important spending  of an average household, that is mandatory and recurring like clockwork, gets only an 8 % representation in the inflation index?That is even more puzzling since in many countries rents are indexed to inflation, i.e. when the CPI rise by, say, 3 %, then in the following year rents will automatically increase by the same amount. Which means that people will automatically spend (33%times 3 %) about one per cent of their incomes more, without any possibility to escape that. In other words, if rents were properly included in the basket, a 3 % CPI rise would already automatically induce another 1 % CPI rise in the following year.And these central bank clowns are scratching their heads about "too low an inflation" and "how to get iut going up"? WTF! It#s all damned lies and faked statistics.

In reply to by Stuck on Zero

Pool Shark Mementoil Thu, 08/31/2017 - 11:08 Permalink

Indeed, the initial borrowing and SPENDING causes inflation.What's left after the initial binge is only the DEBT hangover.When excess debt slows future demand, the result is a DEFLATIONARY recession.Albert is EXACTLY right when he says our interest rates will mirror the Japanese.NIRP here we come.[Cash, Bonds, Gold...]

In reply to by Mementoil

HalinCA (not verified) Mementoil Thu, 08/31/2017 - 14:39 Permalink

Good god ... there is no going back to what you would call normal.  If the FRB tried to do that, the markets would lose 50% of the 'value', pension funds would collapse, and all the disposable income of Boomers would collapse, pushing the economy over the cliff. Get a grip man, what we have lived through the last 8 years is normal.  The political and regulatory system has adapted, the AI Algols are in place, the meat puppets aka politicians are all bribed and lubed, and the Banksters have coordinated their actions so they expect to control market values and fluctuations forever.Or at least until this generation dies off.  The next one will reintroduce honest to goodness serfdom.The theories they taught people in Econ and Business schools up to 2008 are obsolete.

In reply to by Mementoil

Batman11 Thu, 08/31/2017 - 09:19 Permalink

The debt based economy just fails when debt maxes out. Sub-prime mortgages maxed. outSub-prime auto loans maxed. outPayday loans maxed. out Greece Keynesianism is actually sustainable capitalism. They tried running an economy on debt in the 1920s. The 1920s roared with debt based consumption and speculation until it all tipped over into the debt deflation of the Great Depression. Keynes looked at the problems of the debt based economy and came up with redistribution through taxation to keep the system running in a sustainable way.The cost of living = housing costs + healthcare costs + student loan costs + food + other costs of livingDisposable income = wages – (taxes + the cost of living)High taxation funded a low cost economy with subsidised housing, healthcare, education and other services to give more disposable income.Keynesian ideas went wrong in the 1970s and everyone had forgotten the problem of the debt based economy that he originally solved. Rinse and repeat.  

Retired Guy Batman11 Thu, 08/31/2017 - 15:51 Permalink

Keynes didn't fix the depression or solve debt. He did give the government permission to make capital improvements like Hoover dam. That was good. Some now think just throwing money at anything is like building hydro dams. It isn't. WW2 ended the depression. The Hoover dam and a bunch of other capital investments helped. Keynes called for the government to run a surplus during expansions and a deficit during down turns. The government turned out to be incapable of running a surplus. It just wasn't politically possible.Where we really went wrong in modern times was the dot-com frenzy. The Fed should have let interest rates rise to control the speculation. Instead they moved interest down. Now they do all manner of easy but wrong things to keep the rate down. Again there isn't political backbone enough to let a correction correct. They have taken the 'destroy the currency path' from which no government seems able to escape once started.

In reply to by Batman11

Kidbuck Thu, 08/31/2017 - 09:21 Permalink

As an old retired coot, me and my age cohort friends spend more on meds and doctor visits than we do on food or housing combined. Nothing is any cheaper today than it was last week or the year before. The govt numbers are to fuck the CPI so that COLA can fuck over the retired and working stiffs.

You want to see the state of the economy? Look at the cashiers and bag boys at the grocery store. 50 years ago the cashiers were predominately young women and the bag boys were teenagers. 15 years ago all bag boys were illegals. Today the cashiers and bag boys are old people that can't ever afford to retire.

NumNutt Kidbuck Thu, 08/31/2017 - 09:54 Permalink

Amen brother. I point that shit out to people all the time and they look at me like I am crazy. Do people honestly think a 55 year old person likes working at McDonalds? Is he doing it to "just have something to do"? Hell no, trust me if you took the time to ask him if he would rather be working at McDonalds or be at a baseball game they would take the later. The economy is fucked, and it is especially fucked for the individuals that never developed a skilled trade, or worked their entire life on an assembly line turning the same bolt for 20 years thinking their union pension was going to kick in at age 55. It is a sad thing to see and realize what is going on in this country. Brings to mind an old saying - Life is tough, and it is even tougher if your stupid.

In reply to by Kidbuck

markitect NumNutt Thu, 08/31/2017 - 10:27 Permalink

So here's my question: we all have noticed this going back to at least the 2001 recession, we all talk with our neighbors about it and compare stories, the majority of the country agrees we've been shafted, robbed, fu*ked over, yet nothing is done about it and the looting continues unabated.  We are a representational republic correct?  Shouldnt 20 years of ground up anger have produced a change or result by now via the political body?  I guess you could point to Trump but that's one man, what about all the reps out there at the state and local levels?  

In reply to by NumNutt

Nostradumbass markitect Thu, 08/31/2017 - 12:21 Permalink

The populace has been almost completely dumbed down by education, entertainment and cultural marxism. We have become lonely and isolated via technology and social media. Fat, unhealthy, sloppy and with no real sense of community, we schlep through the tedium of this modern world. A feeling of powerlessness pervades. There is no unified voice standing up to and demanding that our enemy be routed from among us. 

In reply to by markitect

GodHelpAmerica (not verified) Thu, 08/31/2017 - 09:28 Permalink

This "deflation camp" needs to die. Look at where real yields are already globally. The money printing will increase into any perceived drop in prices,
because if it doesn't, the hard defaults begin the next day.

GodHelpAmerica (not verified) Thu, 08/31/2017 - 09:27 Permalink

Inflation metrics have been underreported for decades, and today this is especially the case so policy makers can continue with their MO of financial repression.

fzrkid Thu, 08/31/2017 - 09:28 Permalink

Since when are lower prices for a widget a bad thing? Hurry one day only sale, pay 150% of the original price. Would probably not sell many items.

FreeNewEnergy Thu, 08/31/2017 - 09:35 Permalink

@ Five Star, thanks for the excellent read. Bookmarked the site. Good source for unfiltered opinion.Another fallacy, everybody says credit borrowing is bad. If that were true, and everybody took heed, the economies of all major countries would implode.So, credit borrowing in itself isn't bad. The abuse of such is. It's a useful tool, especially now, if one can borrow at "reasonable rates," spend on items falling or at least holding their value. I've been borrowing at 0% and buying silver for the past few years. Silver's been down to stable, but the cost of borrowing isn't hurting me.Yeah, credit is bad. Tell that to anybody with a mortgage on a decent home.Much BS to spread around, everywhere.

taketheredpill Thu, 08/31/2017 - 09:37 Permalink

Imminent deflationary prints notwithstanding, Edwards still thinks rates should be normalised. Why? "Well, because the longer the current credit excesses are allowed to continue, the deeper the next recession and deflationary bust will ultimately be." The FED is hanging onto a rising balloon and are afraid to let go because they might (and probably will) break their legs.But if they hang on and go even higher.... Note that the OER is pushed around by energy prices, inversely I think, so lower NatGas will push OER higher.  I think can't remember.

Dr.Engineer Thu, 08/31/2017 - 09:38 Permalink

Here is the secret:  people are getting wage increases which is going right into paying more for health care (net-net is a deficit).This is the reason that inflation doesn't register:  health care isn't in that measurement.This is also why the savings rate is down. 

Gadocat Thu, 08/31/2017 - 09:46 Permalink

If the tax rate was 100%, we would have systemic deflation.  That is what is happening now as all household income is spoken for.  Only a significant decrease in the tax rates will begin to reverse the situation.

GETrDun Thu, 08/31/2017 - 10:04 Permalink

Prices are the same but the product is smaller. for efficiency ya know..You pay the same, we give you less program. Masking inflation.

khakuda Thu, 08/31/2017 - 10:08 Permalink

All this tells you is that people can't afford to have costs rise when their net pay doesn't.  Since 2008 and probably longer, the market has been trying to bring price levels more into line with incomes, but the central banks have fought it every step of the way to keep the massive and increasing debt from going bad.  The problem is that most regular people are already living paycheck to paycheck, are up to their eyeballs in debt and have little retirement savings.Instead of working to clear the system over time, central banks decided to dig the debt hole even deeper and we are to the point where there is no nice way out.

SilvaDolla Thu, 08/31/2017 - 10:08 Permalink

My REAL WORLD economic indicator is that my mother-in-law hasn't bought me any new underwear for Christmas in almost 4 years because she can no longer afford to do so.

I'm am now positioned Short underwear, but long physical silver, bullets and homegrown vegetables.

BigSwingingJohnson Thu, 08/31/2017 - 10:12 Permalink

according to my calculations, core inflation is negative: minus food, gas, housing, booze, drugs, hookers, bribes, cloths, soap, toilet paper, ammo, ect. the only thing missing is the collection bowl at the catholic church. and since I usually take cash out from it, negative inflation for me.