Yellen makes global markets puke
The Fed chief’s reliance on outdated models rattles investors
With the oil price down $44.5 for WTI (just where it was before the US election), 10-year breakeven inflation at only 1.7%, and major price indices signaling slowflation, the Fed is sticking to its story: Tight labor conditions mean higher prices. Google “Phillips Curve,” and the definition that pops up is: “A supposed inverse relationship between the level of unemployment and the rate of inflation.” There are lots of other things, though, that influence the price level, like technology displacing higher-paid workers and horizontal drilling extracting oil at ever-cheaper prices.
Equity markets didn’t mind yesterday’s unexpectedly low inflation and retail sales report, believing that the Fed would become more cautious. But when Fed Chair Yellen dismissed the disinflation signals from the Treasury market as “unreliable” and attributed the Fed’s lousy inflation forecast to a few “idiosyncratic” anomalies (mobile telephony and pharmaceuticals), investors became alarmed.
Yellen is manifestly wrong on the numbers: as Asia Unhedged showed in a set of charts yesterday, the supposed recovery in the inflation rate was due to a one-shot recovery in housing prices after the 2008-2009 crash. This masked a weak underlying price picture. It’s the earlier recovery in the inflation rate that is “idiosyncratic,” not the recent downside surprise.
It’s not that a quarter-point here or there matters to a global economy that isn’t borrowing dollars to begin with. Commercial and industrial loan growth has fallen to nearly zero. That is a failsafe sign of disinflation: Corporations don’t want to take on debt to buy physical assets. They would rather sit on cash. S&P 500 companies are sitting on a $450 billion cash hoard. The desire to hold cash rather than physical assets is the main determinant of inflation or deflation.
Yellen’s commitment to the Fed’s discredited academic models is frightening. Investors feel like passengers in a ship whose captain has her head stuck in a VR headset. There may not be any rocks in the immediate vicinity, but the passengers already are looking longingly at the lifeboat.