While the US is celebrating a (supposed) recovery, other big parts of the global financial system are behaving as if some sort of deflationary crash is just around the corner. In Europe, for instance, interest rates are not just declining, they’re plunging. From a recent Sober Look blog:
The Unprecedented Chase for Yield
The major market surprise of 2014 so far has been the extent of investors’ appetite for yield in the developed fixed income markets. It has been quite spectacular. The Eurozone in particular has been a key beneficiary of this trend. We’ve seen German government bond yields hit a low not seen in almost a year (see Twitter post), but the real action has taken place in the periphery bonds. We are seeing multi-year and even all-time lows in government bond yields.
And this trend is not limited to sovereign paper. European corporate high yield bonds are now yielding just over 3.6% on average – a record low. Let’s just put this in perspective – this is sub-investment-grade paper trading at these levels.
Why are European crappy-bond yields collapsing? Because everyone now expects the European Central Bank to start buying this paper at any price. From today’s Sober Look:
The ECB Focusing on Downside Risks
The ECB struck a dovish tone this morning, with Draghi hinting that the Governing Council is prepared to take action.BBC: – He said that the 24-member ECB council was “dissatisfied about the projected path of inflation” and is “not resigned to have too low inflation for too long a time”.
… he added that the ECB was “comfortable with acting next time”, raising expectations that the bank could alter policy in June.
Eurozone bonds rallied in response, with periphery yields hitting new lows.Draghi: – … although labor markets have stabilized and shown the first signs of improvement, unemployment remains high in the euro area and, overall, unutilized capacity continues to be sizable. Moreover, the annual rate of change of MFI loans to the private sector remained negative in March and the necessary balance sheet adjustments in the public and private sectors continue to weigh on the pace of the economic recovery.
The risks surrounding the economic outlook for the euro area continue to be on the downside. Geopolitical risks, as well as developments in global financial markets and emerging market economies, may have the potential to affect economic conditions negatively. Other downside risks include weaker than expected domestic demand and insufficient implementation of structural reforms in euro area countries, as well as weaker export growth.
However it remains unclear what options the ECB really has. A traditional bond buying program could be difficult, given the unease in the Eurozone core with the central bank taking on more periphery credit risk. And a program focused on ABS and other consumer and corporate credit products will be limited in scope (see post).
The ECB is hoping that this dovish language by itself will ease monetary conditions. It has worked so far by lowering bond yields and capping euro’s appreciation. But with the Eurosystem’s balance sheet continuing to decline (draining liquidity), will talk be enough?
Eurosystem consolidated balance sheet (source: ECB)
And then there’s China, as reported by London’s Telegraph:
China Deflation Fears as Price Rises Slow Sharply
Concerns That China could be slipping into deflation were sharpened on Friday as official figures showed annual inflation fell sharply in April to its lowest level in 18 months, raising concerns about the risk of deflation in the world’s second-largest economy.Annual inflation fell to 1.8pc in April, its lowest in 18 months, the National Bureau of Statistics (NBS) said in a statement. This compares with 2.4pc in March and was the slowest pace of growth since October 2012, when inflation stood at 1.7pc.
The April figure was also well below the 3.5pc annual inflation target set by Beijing and added to analysts’ worries that deflation could be looming as Chinese growth slows.Moderate inflation can be a boon to consumption as it encourages consumers to buy before prices rise, but economists say falling prices encourage consumers to put off spending and companies to delay investment, both of which act as brakes on growth.
The producer price index (PPI), a measure of costs for goods at the factory gate, fell by 2pc year-on-year in April, the NBS said in a separate statement, its 26th month of deflation, albeit less steep than its 2.3pc decline in March.
“As the PPI inflation remained negative for more than two years and the PPI is an important leading indicator for CPI, the risk of deflation is looming large on the horizon,” ANZ economists Liu Ligang and Zhou Hao said in a research note.
Bank of America Merrill Lynch economists Lu Ting and Zhi Xiaojia said in a report that the CPI figure was “below market expectations” and reflected “the weakness of aggregate demand including both consumption and investment”.
A survey of China’s manufacturing sector by HSBC showed the sector contracted for a fourth consecutive month in April. In contrast, last week the government’s official survey remained in marginal expansion.
Some thoughts
Remember that this tip into deflation is happening after five years of economic recovery. Generally by this point in a cycle deflation is the last thing anyone is worried about. It’s all asset bubbles and accelerating prices and anxiety over when the central bank or the bond vigilantes will start aggressively raising interest rates. This time around the global financial system is suffering from a serious case of bipolar disorder, with bubbles in equities, art, and high-end real estate pushing up asset prices, while in Europe and China growth is slowing and consumer price inflation is trending towards zero.
How can these conditions co-exist? Blame it on debt, old and new. The global recovery was due mainly to China borrowing something like (no one really knows for sure) $15 trillion and spending it on infrastructure projects which pumped up demand for pretty much everything everywhere. But the now-completed projects aren’t generating enough cash flow to cover the related interest. So huge sections of that economy are grinding to a halt.
Europe’s excess debt was taken on in the previous recovery, and now sits like a lead weight on the balance sheets of Spanish homeowners, Greek small businesses and German banks. No one wants to borrow or lend while still encumbered by the mistakes of hubris past.
Meanwhile, the ECB has been operating as if it were a legitimate central bank in normal times, by focusing on stable prices and a strong currency.
A strong currency did indeed used to be a sign of wise monetary policy. But in a system with excessive debt, it’s a recipe not for stability but for crisis, as existing debt has to be paid off in more expensive currency and the resulting deflation becomes a “capital-D” Depression. This is the modern central banker’s nightmare, and the reason why the ECB appears to have accepted the inevitability of vacuuming up trillions of euros of sub-prime debt.
So which trend wins? Do soaring equity and real estate prices take the world into an inflationary spiral, or do falling prices in Europe and China pull down everything else? Or do they offset each other and produce another five years of low growth and rising inequality?
That depends on how the bubble sectors respond to the ECB’s shock-and-awe debt monetization — or to China’s, when and if its credit problem becomes a credit crisis. Because the one thing that we have (or should have) learned from the past few decades is that new currency, once created, goes where it wants to go rather than where its creators hope.
Nothing personal, but in my mind this piece is rubbish. The first sentence starts it all off in suggesting there is a recovery of sorts here in the U.S. Anyone with half of a brain knows otherwise. Then there is this paragraph – “Moderate inflation can be a boon to consumption as it encourages consumers to buy before prices rise, but economists say falling prices encourage consumers to put off spending and companies to delay investment, both of which act as brakes on growth.” This is all economic nonsense in my opinion. Falling prices encourage consumers to put off spending? This is silliness, unless you are talking about plunging home prices which are deflating after a massive asset bubble. In this case, yes, buyers would be waiting until home prices stabilized in order to not be stuck holding onto a still-plunging major asset.
And what is wrong with deflation? I’ve decided that deflation is a non-problem. Sure, asset deflation can cause people to lose their homes after a housing bubble (and that IS a problem), but otherwise is a problem for the banksters only. So bubble prices are falling (housing, fine art, stocks, bonds) – that means prices are normalizing to fair market value, and assets are becoming more affordable. Wow, just think – if houses become cheaper, people will be able to save more and have more money to spend on other things and to put into their retirement savings! Oh gosh, what a disaster. Same thing with stocks and bonds – sure people will lose money in their retirement accounts, but stocks and bonds are manipulated to mega bubble status at the moment, and prices need to normalize and become more affordable.
Delation is a problem for the banks. The banks will be the ones who lose. Fair market valuations would be restored by deflation.
I agree
*Supposed* recovery. You missed a word.
Furthermore, yeah, he says that a strong currency used to be a sign of a healthy economy. In sound economies deflation is indeed a non-problem, as there should be a bit of price deflation due to increases in productivity and improvements in technology. But because the current debt-based financial system is deeply unsustainable and fragile, if deflation takes hold it could trigger an enormous deflationary spiral. These are not normal times. We’re in bizarro land.
That the eventual collapse is inevitable, and that it might be best to get it over with sooner rather than later, is not in dispute here as far as I can see.
And while virtually everyone now agrees that the big banks are parasites and many things are overpriced, that doesn’t mean it’s going to be fun when the banks fail. Just for starters that will mean a halt to international trade and many corporate payrolls, as both are funded on a week-by-week basis by letters of credit and commercial paper. I’m all for killing the parasite, but don’t think it’s not going to hurt.
Where I am working (in silicon valley), there seems to be a recovery. Every social meet-up meeting, the sponsor announced that they are hiring. My employer’s parking lots are so full that they have to use valets for parking (the valet does not park the car, they just shift the cars around later in the day when you want to leave). The IPO market is hot, and so is the merger & acquisition market. Google seems to buy a new company every 2 weeks whether they need to or not. The real estate market is white-hot, we were hoping to buy something but the slim pickings are gone in 48-96 hours, often for teardowns and whole-house rebuilds. These are all symptoms of the final stages of an economic cycle, but no signs of collapse yet, here in Silicon Valley.
You ask, Do soaring equity and real estate prices take the world into an inflationary spiral, or do falling prices in Europe and China pull down everything else? Or do they offset each other and produce another five years of low growth and rising inequality?
Debt deflation commenced Friday May 9, 2014, as most Equity Investments and most Credit Investments traded lower, as all The Currencies, that is the Major World Currencies, DBV, and the Emerging Market Currencies, CEW, except the India Rupe, ICN, traded lower at opening, with the result that the US Dollar, $USD, UUP, popped higher, and closed higher at 79.95, causing disinvestment out of Global Financials, IXG, Nation Investment, EFA, World Stocks, VT, and Dividends Excluding Financials, IXG, as the Bond Vigilantes called the Interest Rate on the US Ten Year Note, ^TNX, higher from 2.60% to 2.62%, in exercising their control over the US Federal Reserve. Electric Utilities, PUI, XUI, and Global Utilities, DPU, such as China Utility, HNU, traded strongly lower on the higher Benchmark Interest Rate, $TNX.
Inasmuch as investors fear that the word central banks have crossed the rubicon of sound monetary policy, and have made money good investments bad, investors sold out of Banco Santander, STD, which led the European Financials, EUFN, the European Stocks, EZU, and the European Small Cap Dividend Stocks, DFE, lower. Greece, GREK, led the Eurozone Nations, lower, as the Euro, FXE, fell lower to close at 135.75.
Deleveraging out of the Euro Yen Currency Carry Trade, EUR/JPY caused Spain’s Telecom Company, TEF, to trade strongly lower.
The Canadian Dollar, FXC, traded lower, causing disinvestment out of Canada Small Caps, CNDA, -2.7%, and Canada, EWC, -0.8%. Deleveraging out of the Canadian Dollar – Japanese Yen Currency Carry Trade, caused Global Energy Producer IPW, Encana, ECN, to trade 2.2% lower.
Most of the High Beta ETFs, such as Retail, XRT, that had sold off so strongly, traded slightly higher.
Natural Gas, UNG, traded strongly lower. Bloomberg reports Iron Ore Slumps to
Lowest Since 2012 as Surplus Deepens. Iron ore retreated to the lowest level since 2012, capping a fourth weekly loss and nearing $100 a ton, as increased seaborne supplies of the steelmaking raw material boosted a global glut. Ore with 62 percent content delivered to the Chinese port of Tianjin fell 1 percent to $102.70 a dry ton, the lowest level since September 2012, according to data from The Steel Index Ltd. The
commodity dropped 23 percent this year, after falling 7.4 percent last year.
The failure of credit on May 9, 2014, was the most significant event in economic history since President Nixon took the US off the gold standard in 1971, and pivoted the world from the age of credit into the age of debt.
While Junk Bonds, JNK, traded higher, other High Yielding Debt, led Aggregate Credit, AGG, lower; the 30 Year US Government Bond, EDV, traded down more than the US Ten Year Note, TLT; Floating Rate Notes, FLOT, traded lower; and the Steepner ETF, STPP, traded higher, reflecting a steepening of the 10 30 US Sovereign Debt Yield Curve, $TNX:$TYX; and the Zeroes, ZROZ, led Popular Notes And Bonds lower; all evidencing the failure of credit.
All Credit Investments, together with all Equity Investments, will be trading lower in a see saw destruction of fiat wealth.
Derisking out of Debt Trade Investments, and deleveraging out of Currency Carry Trade Investments, caused Global Growth Investment, DNL, such as Mexico Cement Manufacturer, CX, to trade lower, and introduces Destructionism replacing Inflationism, with the result that the much feared global economic deflation is inevitable.
Look for strong disinvestment to come out of The Most Carry Traded Nations, as Major World Currencies, DBV, and Emerging Market Currencies, CEW, collapse on the ongoing failure of credit, that began in April 2014 when, China, Russia, Developing Europe, and the US Small Caps trading lower.
Fiat money was coined by the Creature from Jekyll Island, and was a function of the age of credit. The new money, diktat money, defined as the mandates of regional fascism for regional security, stability and sustainability, is coined by the Beast Regime of regional economic governance and totalitarian collectivism, and is a function of the age of debt servitude.
No, Yes, Yes
This is directed at the west’s central bankers. Man, these guys suck!
I think all of this – these apparent contradictions of falling interest rates in the face of asset appreciation – can be explained from the most macro perspective of all: That the constantly growing money supply is forcing prices of everything higher. Obviously asset prices increase as more and more money “invests” in them – or is at least available to support higher bids, but so do bond prices which means their yields must go down. Of course, money doesn’t have to go into any particular investments, and it didn’t when all the monetizations started back in 2009 (equities and real estate were the preferred ones) but now that there is evidence of asset bubbles in those areas, and the threats of geo-political problems and slowing economic growth worldwide, and most importantly of all the constantly growing money supply that may be poised to increase even more because of possible ECB “QE” and an increase from the BOJ, bonds in general may be the least bad option left. Again, the money has to go somewhere. The drop in yields are the mathematical consequence of rising bond prices and demand. They are also indicative of the constant devaluation of “money” worldwide.
Well said Thank you
I don’t get it. Why would any kind of ‘Deflation’ ever be regarded as shocking? Not to me it isn’t. Inflation, on the other hand, is a black tax that I’d rather not pay thank you very much. I can understand inflation that exists, for example, as a result of a scarce product garnering increased demand, but inflation for inflations sake (due to excessive printing/devaluation of a currency or to enable the robbery of the masses) is an absolute non-requirement. There is not a single argument on earth that would convince me otherwise.
Deflation would be a “shock” because most people have been expecting price inflation to occur as the result of worldwide currency devaluations, and because price inflation has been the stated goal of every central bank’s efforts, and most people believe that central banks will eventually get what they want. And they probably will – eventually – even if economic stagnation occurs first.
Stagnation will occur as well as collapse of the dollar
correct analysis
As far as I know deflation is bad now mainly because of the high debt levels. Deflation means overall debt is harder to pay because money becomes more valuable.
Besides, if deflation is taking place in housing, this will send many people to go broke because the collateral for their debts (real estate) is sinking but they still need to pay their debt.
Deflation in housing, inflation in food.
Inflation in rentals, deflation in one family homes, Groceries….up, up and away.
Deflation is occurring because of technology and automation.
We can produce better stuff for less, so whats wrong with that.
means we have more money to spend.
If 100 years of inflation has been bad in that it reduces the value of our currencies then why would 100 years of deflation be bad ?