Gold, Inflation or Deflation

by Laura Ehrenberg-Chesler on January 22, 2015

in currencies,Fed policy,Foreign Markets,gold,inflation/deflation,interest rates

I distinctly remember about 2 years ago hearing from a number of clients that they were convinced rampant inflation was imminent.  Many of these individuals were buying physical gold and storing it in a bank, or in a safe.  In spite of the major injection of liquidity over the past six years from Central Banks around the globe, today the concern is not about high inflation, but no inflation or even deflation.

From Ed Yardeni this morning:

“Why are all the major central banks concerned that inflation is too low, with some even worrying about deflation, given that they’ve been ultra-easy since late 2008?  Consider the following:  (1) Fed.The Fed’s assets have increased 279% since September 2008 thanks to a series of QE programs. Yet the core CPI inflation rate was down to 1.6% y/y during December. That’s despite a 2.9% increase in the rent inflation component, which accounts for 40% of the core CPI. The Fed actually targets the core PCED inflation rate.

“Moreover, Mr. Rosengren [who is the President of the Reserve Bank of Boston] doesn’t have great confidence that inflation will move up as expected, especially given the behavior of long-term interest rates in recent weeks. Yields on 10-year Treasurys have fallen below 2%, a sign investors expect lower inflation even though the Fed thinks it will go up. He said there was a disconnect between this market behavior and the Fed’s confidence that inflation was moving up.” Rosengren isn’t a voter on the FOMC this year, but he is an influential dove.

It’s not obvious that QE will revive inflation in the Eurozone given that it didn’t do so in the US. Perhaps inflation would have moved lower in the US without QE, though I doubt it. Given that government bond yields have plummeted close to zero in the Eurozone, QE’s mission has already been accomplished in the bond market, in my opinion.

The only transmission mechanism that I see between QE and inflation is through the currency. If the euro continues to plunge as a result of the new QE program, then the Eurozone’s economy might get a lift from exports and fewer imports. That could boost inflation, I suppose. However, I remain skeptical given Japan’s recent disappointing experience with quantitative easing, which was only 1.4% during November.  Meanwhile, inflation continues to fall in the Eurozone. Thanks to falling oil prices, the headline CPI inflation rate was -0.2% y/y during December. The core rate was 0.7%.

In addition to these data points, the Bank of Japan recently cut its inflation forecast as did the U.K. and commodity prices, including oil, natural gas, and copper have all declined dramatically in the past six months.

Certainly at some point this 0%-low inflation environment will reverse.  But, this recent about face for inflation is a good reminder to take a measured, middle of the road approach when attempting to evaluate the markets, and invest in them.



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