Jerome Powell went out of his way during the October press conference to offset any perceived hawkishness associated with his upbeat comments on the trade war.
He did that by emphasizing that inflation would have to surge before the Fed would consider hiking rates.
“We really don’t see that risk” of a sharp upturn in inflation. “We’re not thinking about raising rates right now”, he said, in response to a question from a reporter.
That effectively meant that although the committee is keen to remain on hold in the hope that trade tensions won’t escalate and that the expansion will get new life from the trio of “insurance” cuts delivered since July, the bar for rate cuts is much lower than the bar for more hikes.
Well, SocGen’s Albert Edwards wants to know what the Fed plans to do if the US suddenly slides into deflation.
“But what if the reverse happens?”, Edwards asks in a Thursday note, referencing Powell’s comments about a sharp rise in inflation. “GDP growth looks fragile and there is good evidence to suggest that core CPI inflation is set to collapse towards zero”, Albert goes on to say.
What, you might ask, does he mean by “good evidence”?
Specifically, Albert zooms in on shelter inflation. To wit:
The October CPI data shocked me not for the surprisingly high 0.4% headline rise mom, but because inflation in the key shelter component collapsed to almost zero. Shelter has a very heavy 33% weighting in the overall CPI and an overwhelmingly dominant 42% weighting in the closely watched core CPI (ie ex food and energy). I had been waiting for a while for the shoe to drop and now it has started to fall towards the floor, revealing that core CPI inflation in the US is closer to zero than many assumed.
As alluded to in the excerpted passage, this is ostensibly consequential. As Albert goes on to note, “inflation for core CPI has exceeded the core PCE deflator since 2014, primarily because the dominant shelter component has been running around 3½%, pulling up core CPI sharply”.
Assuming that cools off and the “rapid burst” of inflation in health insurance premiums eventually subsides (wishful thinking, perhaps), CPI will decelerate, Edwards postulates, before pointing to some “key leading indicators” that help make the case.
For example, here’s core CPI and ISM on a lead:
Edwards then points to falling home prices, on the way to saying that “this will come as a surprise to investors, [but] even without a recession, core CPI could quickly head towards zero”.
Next comes Japanification, which the US will “embrace” just like Europe has been forced to do. Or at least that’s Albert’s thesis. He shudders to think what would happen in an outright recession:
And the obvious question arises that if this is all the consumer price inflation that the US economy can produce at the end of the longest cycle in history, what will happen when it falls into recession?
It’s worth noting that Deutsche Bank’s Stuart Sparks – who isn’t, like Albert, famous for any “Ice Age” theories or for adopting a persistently dour economic narrative – has variously suggested if the dollar refuses to roll over in earnest, the Fed could be forced to cut rates aggressively irrespective of whether a recession comes calling in the US.
Indeed, assuming the US economy holds up and the expansion drags on, there’s an argument to be made that relative economic strength and comparatively “hawkish” US monetary policy will serve to bolster the dollar, leading to more imported disinflation. “There is a problem here that begins to smack of inevitability”, Sparks wrote back in September.
The only way out of that situation is if the global economy inflects for the better, allowing policymakers abroad to adopt a less aggressively dovish tone. Suffice to say that doesn’t seem likely at the current juncture.