Tuesday, April 20, 2010

More on Deflation Risks

I had a good meeting with some clients this morning. However, an issue came up which brought to mind my favorite topic these days: namely, the risk of deflation.

My clients were discussing some property they wanted to buy, and they wanted to move the transaction along quickly since everyone knew interest rates would be higher by the end of this year.

When I asked how they "knew" rates would be higher, they looked at me with a funny expression: How could interest rates not be higher?

Well, in a deflationary environment, interest rates move lower, not higher. The massive deleveraging trend that we are seeing in the consumer, and the large cash "hoarding" by corporate America, all indicate that prices in general are moving lower, or at least not rising.

As I repeated often on this blog in recent weeks, the trend of prices seems to be moving lower, not higher. I read a piece from the research outfit Ned Davis Research, Inc. which highlighted a couple of these trends:

  • Core CPI fell to 1.1% from 1.3% on a YOY basis in the most recent report, the slowest pace since November 2003. Median CPI fell to 0.6%;
  • Manufacturing unit labor costs fell 6.6% last year, the most since the data began in 1947;
  • Essentially all inflation indicators are lower than when Bernanke began to worry about the risk of deflation in 2002-03.

Ned Davis Research thinks the Fed will not raise rates any time soon; I agree.