Albert Edwards: Europe On The Edge Of A Deflationary Precipice

Given our view that this cyclical recovery will end surprisingly early, slipping into the deflationary mire will trigger further, more extreme rounds of Central Bank monetisation, inevitably driving us towards our ultimate destination – 1970’s style 20-30% inflation will surely return, SosGen analyst Albert Edwards says.

“Governments have no option but to stimulate aggressively all the while the private sector is de-leveraging.”

Albert Edwards


“Amid all the recent euro-related turbulence, the markets have not focused enough attention on the rapidly vanishing core CPI inflation rates in the US and euro zone. With both moving below 1%, we are now only one cyclical mishap from joining Japan in outright deflation,” Mr. Edwards writes in a new analysis.

Adding: “Given our view that this cyclical recovery will end surprisingly early, slipping into the deflationary mire will trigger further, more extreme rounds of Central Bank monetisation, inevitably driving us towards our ultimate destination – 1970’s style 20-30% inflation will surely return.”

“Of all the inflation data released this week, the one that caught the markets’ attention was the UK‘s dramatically higher than expected 3.7% yoy rise for April. Even the core measure of CPI managed to creep up above the 3% mark. Meanwhile the old RPI, to which most state benefits are indexed, rose a heady 5.3% – the highest pace since July 1991. While many commentators proceeded to berate the Bank of England for consistently under-forecasting inflation in recent years, many also saw the first signs of the quantitatively eased pigeons coming home to roost.”

“But I would argue that in a year or so, we will see the UK?s relatively high inflation rate as a godsend. For elsewhere, it went almost unnoticed this week that core CPI inflation rates in the US and euro zone continue to slip-slide their way down towards zero (see chart below). Although this is seen as buoying bond prices at the margin, it is a pernicious development that investors will focus on when this cycle starts to fail. Regular readers will know that I believe that in a post-bubble world, recession follows recession with surprising rapidity. We are now only one cyclical failure away from Japanese-style outright deflation in the US and the euro zone at a time when de-leveraging still has years to run (falling prices bring the risk of a classic debt deflation trap). Impending cyclical failure and a deflation scare will trigger new lows in equities as the valuation bear market finally plays itself out with the S&P falling below 500. We therefore maintain our long-standing target of sub-2% US 10y bond yields – and that is the point when QE will really begin to get serious.”

“But as my old friend Jim Saft pointed out in his Reuters opinion piece yesterday, it won?t just be deflation the euro zone will be exporting but also trade tensions as the dollar rises (link). Jim makes the very good point that “the US primary elections on Tuesday showed voter anger is focused on incumbents in general and Washington in specific. It would not be a surprise for the administration to try and focus that anger outside of the country.” A renewed global downturn with rising trade tensions is exactly the environment that will see the shock Chinese yuan devaluation. I continue to remain of the view that a global downturn is close. Too many are focusing on the buoyant economic data that is entirely consistent with continued strength of the coincident indicators, yet all the while the leading indicators continue to slow (see chart below). Renewed recession will never be forecast until after we are back in one!”

More at: Zero Hedge

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