Back in February, after surviving an earthquake and narrowly dodging a tsunami in Jamaica, SocGen’s Albert Edwards returned safely to work, and promptly predicted that “The Ice Age” (his long-standing thesis describing western markets’ date with deflation) was near its end.
We are, he said, on the verge of transitioning to “The Great Melt”, which will be catalyzed by the adoption of helicopter money across the developed world.
Before we get there, though, Edwards said there may be one final phase of “The Ice Age”, which he called “The Great Meltdown“.
“Notwithstanding short-term market gyrations, I am now more convinced than ever before that the coming deflationary bust will take the US 30-year yield below zero”, he said, adding that “helicopter money will be the chosen way out of this deflationary quagmire, especially as it becomes increasingly clear that there is now no way left to reverse every government’s exploding fiscal liabilities”.
Over the next five weeks, US 30-year yields proceeded to tumble more than 100bps as Wuhan’s problem became the world’s problem and financial markets were plunged into chaos.
The subsequent policy response was unprecedented in a number of ways, not least of which was that the pandemic brought us closer than ever to overt monetary financing. Indeed, central banks have made no secret of the fact that they are enabling fiscal policy with expanded asset purchase programs.
In effect, the pandemic collapse brought forward the final stage of “The Ice Age”. One might argue “The Great Meltdown” played out over a matter of just three months. Sure enough, it was accompanied by a stock market crash, deflation in the US and what might as well be the adoption of Modern Monetary Theory.
Edwards takes all of this up again in his latest weekly. The first thing you should note is that he has little doubt about the state of the policy panic and what’s coming next in that regard. To wit:
This economic bust is so serious and so deflationary that policymakers felt they had no choice but to cross the policy Rubicon. In The Great Melt there will never be any serious attempt to reverse policy stimulus. Indeed we will see more and more stimulus until the deflationary ice melts.
As you can imagine, Albert noticed that core CPI in the US fell a third month for the first time ever in May.
“Previously even a single sighting of a 0.1% MoM decline in core CPI was as rare as hen’s teeth”, he writes. “US core CPI has now slumped into deflation and the markets will find this a most difficult crevasse to bridge”.
On a YoY basis, core declined to just 1.2% last month, the slowest pace in nearly a decade, and just half of where we were in February.
Edwards notes that “excluding imputed Owner Equivalent Rent (OER is not included in the eurozone measure) this comparable measure is rising only 0.4% YoY and falling sharply on a 6-month basis”.
This will be familiar to those who follow Edwards’s work. “High OER inflation (which tends to mirror actual rent inflation) has held up core CPI” for years, he reminds you.
He also takes note of the disparity between consumer expectations for inflation in the US (which are rising) and “delivered” inflation, which is plunging. As noted here on Wednesday, this is attributable in part to the fact that, during the lockdown, Americans weren’t engaging in economic activity in the areas where prices have plunged. They were, however, shopping for groceries (food at home prices have surged) and reading dire-sounding headlines about meat shortages tied to shutdowns at processing facilities.
In any case, Albert goes on to say that “the slump in inflation feeds into the core” of “The Ice Age” thesis and has implications for stocks as well.
“Nominal GDP growth will slow further and drag down analyst forecasts of long-term EPS growth, which are already weighed down by the ongoing profits collapse”, he says, before warning that falling core CPI stateside is ushering in the Japanification of US nominal growth on top of an economy that is weighed down by debt.
If the projection in the left pane is correct, it will not bode well for long-term earnings, and that, in turn, could prompt a reality check for what Albert continues to decry as “nose-bleed expensive” PEG ratios (right pane).
None of that means he doesn’t still believe the “The Great Melt” is coming. Rather, he simply thinks “The Great Meltdown” has a while longer to run.
“Massive monetary stimulus is combining with frenzied fiscal pump-priming in an attempt to paper over the current slump”, he says. “But before markets can properly embrace ‘The Great Melt’, they first need to comprehend the new normal: deflation has arrived”.