Were you feeling a bit chipper on Thursday, comforted by the promise of a long weekend?
Well, there’s nothing like a healthy dose of Albert Edwards to curb one’s enthusiasm.
The latest from SocGen’s incorrigible – but affable – perma-bear finds Edwards in rare form, picking apart the global central bank victory lap with a rather devastating look at inflation expectations and the extent to which (willful) ignorance is bliss when it comes to base effects from higher crude prices.
This is actually a really good note. That’s not to say that Edwards’ other recent missives aren’t good, but rather he seems to have actually sat down and thought about this one as opposed to resorting to the old stream-of-bearish-consciousness, “my ‘ice age’ thesis still applies, I promise” rant.
The first paragraph is vintage Edwards and he even manages to get in a Marc Faber reference for a little extra “doom-age.” Read below and enjoy as the sellside’s greatest bear speaks on the dangers of hubris…
Commentators are always on the lookout for quirky indicators that suggest trouble might lie ahead. For a country, one good indicator of a forthcoming economic collapse has always been the Skyscraper Indicator. For an individual, appearing on the front cover of Time Magazine is seen as the kiss of death for one’s career. Being called ‘maestro’ didn’t do much for Alan Greenspan’s career! Alternatively analysts keep an eye on the size and glossiness of company annual reports as a sign of hubris. Also check out what baubles companies put in their entrance atriums (at my previous shop the management thought it a good idea to have a Formula 1 racing car in the hallway). Now we have central bankers patting themselves on the back for having done a jolly good job. That surely is the most worrying, hubristic signal of all.
Hows this for Grade 1 central bank hubris; Peter Praet, the ECBs chief economist said in a recent interview that, “Since the crisis we have had serious concerns about deflationary risks on several occasions in the euro area, but now we can say they have disappeared.”
Really? Has he seen the chart below, which shows core CPI in the eurozone heading sharply lower and now approaching its all-time low seen at the start of 2015! Not only that, but eurozone inflation expectations are also declining again, after surging in the aftermath of Donald Trumps election. To be fair, Praet was focusing on the rise in headline inflation in the eurozone, which touched 2% in February before dropping back in March to 1½%. After some 18 months bobbing around the zero mark, I can understand why central bankers might be heaving a sigh of relief, but for them to take credit for a recovery in headline inflation is totally disingenuous given it has been entirely driven by a recovery in the oil price.
Similarly Janet Yellen was quoted saying the Fed is doing pretty well in meeting its congressionally mandated goals of low and stable inflation and a full-strength labour market. Its this sort of comment that has led Marc Faber to want to short central bankers the only way being to buy gold. The increasing volume of central bank hubris may even explain the recent breakout of gold to the upside!
Not a lot is happening in the markets at the moment of any great note, except perhaps the surge in the yen against both the dollar and the euro. The weaker than expected non-farm payrolls and the continued moderate rise in average hourly earnings took the US 10y down to 2¼%, the bottom of its current trading range. Whether it is the flattening of the US 10y-2y curve that is driving the dollar lower or the spread vs Japan is debatable (see charts below). But reduced expectations of a pronounced Fed hike are certainly a key part of the story.
To be honest I am a little surprised that US nominal wages are not showing more of an acceleration given surging headline inflation has crushed real wage growth over the last year. Falling US real wages are already resulting in slower consumption growth, but workers have not yet pushed up nominal wage inflation to compensate for the squeeze in spending power. One might debate how tight the US labour market actually is given the low participation rate, and whether it is sufficiently tight to prompt a surge in nominal wage inflation. In Japan though, there is no such ambiguity with the job offers/applicants ratio already exceeding the peak of the late 1980s bubble economy and yet wage inflation has remained reasonably moderate (see charts below). Maybe the laws of economics have indeed been abolished but I doubt it.
One might have thought the surge in the oil price from its trough some 12-18 months ago might have had more impact on wage inflation, but so far that does not seem to be the case. Yet in the US, for example, the CPI energy component has swung from -15% to +15% in the space of a year and driven headline CPI inflation sharply higher (see charts below). With the oil price stuck in the 50-55 $/bbl range, the yoy surge in the oil price will now subside back towards zero. And although US headline inflation will now likely drift back down towards the core CPI rate, this is at 2¼%, a still substantially higher rate of inflation than that seen in recent years, and it will erode spending power noticeably.
It is not just eurozone inflation expectations that seem to be in retreat. The same thing is happening in the US too (see chart below). I am always surprised how dominated 10y inflation expectations are by short-term movements in the oil price and headline inflation, but it was noticeable just how rapidly inflation expectations ran up in the wake of Trumps election way in advance of what might have been expected by the bounce in the oil price (see chart below).
Despite the euphoria in the markets about the reflation trade, survey inflation expectations have continued to drift downwards. The Conference Board measures 1y and 5y forward inflation expectations of households and these have continued to decline despite soaring headline inflation (see chart below). Again I find this most surprising, but it might help explain why wage inflation is so sticky despite the real wage squeeze. But one thing is certain: for central banks to call victory over deflation may prove very premature indeed. Nemesis awaits.