Albert Edwards: Market ‘Meltdown’ May Return On COVID Deflation Shock

SocGen’s Albert Edwards is on the record suggesting that the fiscal response to the next crisis (which, by virtue of being upon us, can no longer be described as a hypothetical) will usher in a great “melt”, finally bringing an end to the “Ice Age”.

And yet, in the interim, Edwards sees deflation risk, and thinks it won’t be as easily dismissed by investors as the other dour macro data we’re being told to brush aside and otherwise “look through”.

“Falling core CPIs are likely to be much more of a shock to investors than slumping real economy data”, Edwards writes, in a Thursday note, adding that while he does believe “we are transitioning from ‘The Ice Age’ to ‘The Great Melt'”, the near-term landscape is likely to be defined by an “imminent deflationary bust”, which Albert says is “unfolding in front of [investors’] eyes”.

You should note that core CPI did print negative for what might as well have been the first time in nearly a decade last month as coronavirus deflation came knocking.

Specifically, core fell 0.1% MoM. Economists were looking for a 0.1% gain. Again, that means March saw the first material decline below zero in core since 2010.

After discussing that, Albert reminds you that he has “long warned that the next recession would bring about either outright deflation in core CPIs, both in the US and the eurozone, or at least the fear of outright deflation”.

Again, we no longer have to speak in hypotheticals when it comes to “the next recession”. It’s here. We’re in it.

As Edwards writes on Thursday, “despite surging recently, in line with the equity rally, I think [inflation expectations] are going to turn sharply lower again and probably soon fall well below zero”.

(SocGen)

Regular readers may recall that just two days previous, while discussing Howard Marks’s sixth memo in six weeks, I not-so-gently suggested that, at least in the near-term, the idea that fear of “money printing”, direct deficit financing and other forms of monetary and fiscal largesse will overwhelm the deflationary supernova that is COVID-19 is a laughable proposition.

As I put it, Tuesday, “I can virtually guarantee that while inflation expectations may bounce for a spell (especially if oil prices manage to sustain anything that looks like ‘stability’ in the wake of the OPEC+ deal), they will not accelerate meaningfully in an environment characterized by acute demand destruction, no matter how quickly the Fed’s balance sheet grows”.

Importantly, Edwards doesn’t expect a repeat of March, when collapsing breakevens were accompanied by a surge in real yields which in turn contributed to what became a self-feeding dollar strength loop.

“If (when) inflation expectations collapse I do not expect that real and nominal yields will surge again in the way they did in mid-March for one turbulent week when liquidity issues arose”, he writes.

Albert continues, noting that in his view, “the period up until March 9 where both inflation expectations and real/nominal yields all fell together will be repeated”. (Fingers crossed on that, if you’re a gold bull.)

Ultimately, Edwards isn’t confident that market participants can swallow a deflationary spiral with the same degree of alacrity investors have digested some of the recent dour data prints, which he says are “being largely dismissed”.

The overarching message from Albert’s latest missive is that while we wait for the “Ice Age” to thaw under the heat emanating from printing presses running red-hot, “‘The Great Meltdown’ is likely to reassert itself as the dominant near-term investment theme”.

Feel better?