QE vs. Deflation

November 21, 2013
Deflation Is Crushing QE Right Now

Less attention is being paid to the biggest source of risk at present: deflation in the developed world. All of the past week’s data point to heightened deflationary risks. Paltry U.S. consumer price index (CPI) figures, German producer prices undershooting and another bout of weakness in commodity prices, particularly oil, suggest deflation is winning the battle over central bank stimulus. Which is something that Asia Confidential has been forecasting for some time.

The following chart shows the average annual growth in the CPI over the previous 5 years.


Click to enlarge.

1.5% is definitely below the Fed's target rate. The Fed has thrown pretty much everything at it too, including the kitchen sink. Too bad there are so many used kitchen sinks for sale. It hampers their progress.

Short-term market action is always difficult to call though. Long-term trends are easier to distinguish. And on this front, little has changed. You have an ongoing battle between deflation and central bank government efforts to prevent it via QE. Deflation is winning right now, which is why you should expect more QE, not less, going forward.

If that’s right, stimulus and low interest rates could be with us for some time yet. Asset prices may be bid up further. And the market bears may have to wait before a more serious correction happens. The catalyst for that is likely to be a loss of faith in central bank stimulus.

I'm a believer in the loss of faith theory, for what that's worth. Over the long-term, I never had it to begin with. I haven't been buying long-term bonds because of the Fed. I have been buying in spite of them.

It's funny that so much time is spent warning us about a treasury bubble when individually purchased treasury bonds make up such a tiny amount of our personal assets (less than 2%). In my experience, very few people even know how to buy them directly from the government. I'm not judging. I've seen many hours of financial TV in my life and I've never seen anyone offer advice on how to buy a treasury bond. I don't recall the term I-Bond ever coming up either. It's almost like there's no money in it for them if bonds are purchased directly from the government.

This is not investment advice.

Source Data:
St. Louis Fed: CPI