Friday, April 29, 2016

Resurrecting Global Inflation?

Will Martin of Business Insider reports, Europe is back in deflation:
The eurozone slipped back into deflation in April, according to the latest numbers released by Eurostat on Friday morning.

Eurostat’s latest flash data showed that consumer prices in the single currency area fell by 0.2% in April.

Economists had expected inflation to fall by 0.1%, slipping from the 0.0% at March’s reading, so the reading is troubling.

The number means that prices are once again falling, having come out of deflationary territory in March, and are well behind the 2% target set by the ECB for inflation.

On a year-to-year basis core consumer prices grew by 0.8%, against a forecast of 0.9% and a previous reading of 1%.

Core prices are an important measure because they strip out the most volatile items — things like fuel and food prices, which are subject to massive variations.

It is worth noting that Friday’s data is just a flash reading, meaning that it could be revised when the final numbers drop in mid-May.

Here’s an extract from Eurostat’s release accompanying the data:
Looking at the main components of euro area inflation, services is expected to have the highest annual rate in April (1.0%, compared with 1.4% in March), followed by food, alcohol & tobacco (0.8%, stable compared with March), non-energy industrial goods, (0.5%, stable compared with March) and energy (-8.6%, compared with -8.7% in March).
A large part of the eurozone’s extremely low inflation right now is down to the slump in the price of oil over the last year — but the core figure shows that other prices aren’t rising by as much as the ECB would like, either. Here’s a breakdown of the core areas of goods tracked by Eurostat (click on image):


The eurozone has been flirting with price deflation for the past year or so, largely hovering just above zero since early 2015, but slipping below zero a couple of times in early 2016.

Friday’s eurozone CPI figures are the third set to be released since European Central Bank and its president Mario Draghi announced a series of new monetary policy measures, including cutting all its base rates, and extending its programme of bond buying.

The measures are designed to try and boost stalling inflation, as well as growth, within the Eurozone. So far the ECB’s negative interest rate policy (NIRP) hasn’t managed to stimulate inflation, although Draghi said in an interview with German newspaper Bild this week that “our policy is working” when speaking about criticisms of the ECB.
Germany is back in deflation and France is stuck in deflation. Mario Draghi's worst nightmare is playing out right before his eyes, but no worries, Europe's Unilever is joining his deflation fight by deploying a $60 toothpaste to regrow damaged tooth enamel (just what those millions of unemployed in Europe need to spend on as they wait for job growth).

More worrisome, Australia saw deflation for the first time in seven years in the first quarter, as falling petrol, food, and clothing prices drove down the cost of a basket of goods and services.

Over in Japan, there is no end in sight for deflation:
It has become increasingly uncertain when the nation will realize its goal of ending deflation. This is because the Bank of Japan on Thursday pushed back the goal of achieving 2 percent inflation to sometime in fiscal 2017, the fourth such delay in about a year (click on image).

The monetary easing measures taken by the central bank have not been effective in raising prices.

On Thursday, the Bank of Japan issued the Outlook for Economic Activity and Prices Report, which states the recent economic situation and the outlook for prices. It said in the report that the achievement of its price stability target is “projected to be during fiscal 2017.” The bank formerly said the target would be achieved around the first half of fiscal 2017.

The Bank of Japan had previously postponed the timing for reaching the inflation target on the grounds of sharp falls in oil prices.

When the bank started its quantitative and qualitative monetary easing in April 2013, the benchmark crude oil price was around $100 per barrel.

However, the downward trend accelerated after prices peaked in summer 2014, and this year prices temporarily plunged below $30 a barrel — beyond the expectations of the central bank.

Lower crude oil prices drive down the costs of energy such as gasoline and electricity, pushing the prices down as a whole.

Each time crude oil prices dropped, the Bank of Japan reacted by extending the time frame, expecting that the price would slowly increase.

This time, however, Bank of Japan Gov. Haruhiko Kuroda said the bank would make another postponement mainly because of the slowdown in the overseas economy, which has negatively affected the nation’s growth rate as well as wage growth.

As crude oil prices have been increasing recently, the central bank’s past logic no longer explains the downward trend in prices.

However, Kuroda decided not to implement additional monetary easing policies, saying the bank needs to wait and see the effects of the negative interest rate policy.

“The contradictions in the BOJ’s policies are increasingly evident,” said Tsuyoshi Ueno, an economist at the NLI Research Institute. “I think the bank needs to reexamine its policies and start over from scratch.”
Making matters worse for the Bank of Japan, the yen hit an 18-month high versus the U.S. dollar, heightening fears of further deflation:
Analysts said the yen continued to surge in the aftermath of the BOJ's decision to hold monetary policy steady on Thursday in the face of soft global demand and a sharp rise in the yen, defying expectations for increased stimulus to fight deflation.

"It’s just a continuation of momentum after the BOJ policy announcement," said Vassili Serebriakov, currency strategist at BNP Paribas in New York. He said the dollar could weaken to 105 yen before June, when he said the BOJ would likely step in with increased stimulus.
At this writing the USD/YEN cross rate is at 106.88, down 1.2% after falling more than 2% when the BoJ disappointed on Thursday.

A strengthening currency, especially for an exporter like Japan, acts like an increase in rates, tightening financial conditions. It also lowers Japanese import prices and makes it that much tougher to get out of its deflation rut.

Why is the yen strengthening vs the U.S. dollar? Because as inflation expectations decline in Japan, real yields rise, making Japanese bonds that much more attractive to Japan's large pension and insurance companies. This helps explain the yen's puzzling surge.

But a rise in the yen isn't good news for Asian economies struggling with their own deflation demons. As I explained a few weeks ago, the surge in the yen can trigger another Asian crisis via a full-blown currency war in that region. And if this happens, it will mean exporting more deflation throughout the world, including the United States.

Interestingly, even though the U.S. dollar index (DXY) has been declining since the start of the year, helping boost oil prices to fresh new highs, U.S. inflation barely rose in March as consumer spending remained tepid, making it less likely that the Federal Reserve will be able to follow through on its projected two interest rate hikes this year.

The rise in the yen could also spell big trouble for global risk assets as hedge funds unwind the yen carry trade and deleverage out of risk assets. Michael Gayed wrote an interesting comment, Memories Of The Yen Signaling Risk-Off And Correction Ahead?, where he notes the following:
Does the yen's recent movement signal a potential risk-off environment to come in the next few weeks or months? Maybe. The blue line below is the price ratio of the iShares 20+ Year Treasury Bond ETF (NYSEARCA:TLT) to the SPDR S&P 500 ETF. Spikes in the ratio are typical, given that Treasuries have tended to end up having an inverse relationship to stocks in periods of high stress. The black line beneath it is the CurrencyShares Japanese Yen Trust (NYSEARCA:FXY). Note that there was a very tight correlation between the outperformance of Treasuries and the yen prior to the QE3 period of 2013, which distorted many historical signals.


Now, it appears that the movement is ready to sync back together as the rolling 13-week correlation hits the extreme lows of the last 5 years. Why does this matter? Because if the marketplace begins to seriously believe that Japan's fiscal and monetary stimulus is doomed, then the yen likely continues to rise and bring with it a risk-off scare globally. This would cause Treasuries to have another big potential spike against equities.

I'm not fully convinced that will happen right here, right now. Other quantitative indicators we look at suggest things might well be okay in the near term, which is why our Tactical model is fully exposed to equities as of writing (click here to view). Having said that, there is little doubt in my mind stocks won't correct again this year. If the yen continues its march higher, and if indeed its historical role as a risk-off trade is back, then the time to get defensive may soon occur.
Like Michael, there is little doubt in my mind stocks won't correct again this year. Right now, algorithmic and quant traders are having fun ramping up metal & mining (XME), energy (XLE), industrial (XBI) stocks on every big dip, acting as if another global recovery is well underway. Even shipping stocks rallied in April but the reality is deflation is wreaking havoc in that industry and I wouldn't touch any of these stocks.

Why is there such a huge disconnect between actual economic reality (the deflation tsunami is going to hit us) and these stocks which are a play on global recovery?

Two things here. Oil prices have rebounded solidly and there are some smart traders who think they can go much higher from here. Then there is George Soros whose warning on China has thus far proved to be wrong.

But is Soros really wrong about China and have we really escaped the Great Crash of 2016? I wouldn't bet against Soros and I'm increasingly worried about China's big pension gamble and the commodity trading frenzy taking over there and whether a currency war in Asia will bring about another Big Bang which will clobber risk assets all around the world in the second half of the year.

I know, I'm way too pessimistic, the quantitative algos on Wall Street are running the show, it's no use being logical when analyzing risk assets, the "trend is your friend", don't fight central banks, they're on top of it all. Just close your eyes, hold your nose and buy any dash for trash and pray to God Soros is wrong on China.

I'm sharing my thoughts in this comment to make many of you think about downside risks. Sure, there is a lot of liquidity in the global financial system which can drive risk assets much higher (a bubble in commodities?), but be careful here and realize that global deflation is still the primary threat and if we get another financial crisis, it will obliterate oil, commodity and emerging market currencies, stocks, and corporate bonds. The only place to hide will be in U.S. bonds.

Below, CNBC's Becky Quick talks with billionaire investor Warren Buffett about the markets, interest rates and the deficits, telling people not to put too much stock in Icahn's market warning (see below).

Also, John Thornton, the former president of Goldman Sachs (GS), who likes to take the long view, says he’s “feeling uneasy” about the global economy right now and thinks we’re living on borrowed time.

It's Orthodox Easter weekend, so let me focus on the resurrection of Christ and less on resurrecting global inflation and risk assets. I embedded a clip below of someone singing that magical Easter hymn as we see images of Greece's beautiful monasteries.

I wish you all a great weekend and my fellow Orthodox Christians a Happy Easter. Christos Anesti!!




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