Albert Edwards is back with his Global Strategy Weekly note that comes out roughly once every three weeks (remember, that’s not a paradox – Albert can do whatever Albert wants to do, and that includes writing a weekly letter once every three weeks).
In a surprise turn, Edwards is abandoning his long-held ice age thesis in favor of a new, reflationary outlook for the U.S.
I’m just kidding.
The title of his latest is: Underlying US CPI inflation has already slumped into deflation Japan beckons.
That’s right, “Japan beckons,” and this note comes at a particularly opportune time ahead of PCE.
Of course we’d be willing to bet everything we own that one print isn’t going to change Edwards’ outlook one iota and indeed, he wants you to know that going into this year, “he was too optimistic!”
The reality is that you didn’t need Albert to tell you that the reflation narrative is now dead and buried, but it’s always nice to have him around to remind you that things can, and in his mind most assuredly will, get far worse.
We’re going to hit you with the bullet point highlights and leave it to you to go grizzly hunting in search of the full note.
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%.
In the mid-1990s I witnessed first-hand the hubris of western commentators who claimed that Japans post-bubble slide into deflation was a one-off example of Japanese specific policy incompetence compounded by the authorities reluctance to allow companies to go bust in order to liquidate excess capacity.
My former colleague and Japan guru, Peter Tasker, and I came to the conclusion that hubris of western commentators would turn to nemesis. Japans post-bubble experience of sluggish economic growth was due to debt retrenchment followed seamlessly by deteriorating demographics. We felt both factors would also combine to push the west into a similar deflationary bust, despite the best efforts of policymakers (who incidentally would in no way follow the advice they had previously given Japan to liquidate capacity).
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!
Although wages have accelerated due to the tight labour market, the last six months has seen consistent downside surprises. 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. The US has never since the mid- 1960s, when records began, seen core CPI (less food, energy and shelter) decline over a six-month period. Deflation did not need another US recession to emerge. It is already here.