That’s not just my opinion, by the way. It’s what one of the Fed’s own favorite indicators is showing.
I’m talking about the “Five-year Forward Breakeven Inflation Rate.” I know that’s a mouthful, so let’s try to keep things simple. The Treasury Department issues two major kinds of debt — traditional Treasuries and Treasury Inflation Protected Securities (TIPS).
As the name suggests, TIPS offer investors a form of inflation compensation. It’s an extra enticement designed to draw investors in when they might otherwise stay away due to concern that inflation will erode their returns.
You can get an idea about just how much inflation fear is percolating in the marketplace by comparing the yields available on regular Treasuries and the yields offered on TIPS. The higher the breakeven inflation rate, the more worried investors are — and vice versa.
With that in mind, take a look at this chart:
|Deflation the big fear now.|
You can see that this “inflation fear gauge” is falling off the table. In fact, it just dropped to 1.59%.That’s even lower than the 1.97% level we hit in the depths of the Great Recession. Heck, it’s the lowest level going back to at least 1999!
That tells me a few things about the economic and market outlook:
First, investors are saying loudly and clearly that all the QE from the U.S. central bank and its counterparts overseas is utterly failing to bolster inflation. So is the strategy of varying the composition of QE to include stock ETFs or other bonds, rather than just government debt. Pushing interest rates into negative territory? Same story — not working.
Second, investors are clearly saying that widespread commodity deflation in everything from oil to copper to grains to beans isn’t going away. If anything, they’re worried it’ll get worse and therefore aren’t demanding more inflation protection.
|Deflation has hit nearly all commodities, from cooper, to oil, to beans.|
And third, investors are saying that while the U.S. economy has held up relatively well in the face of multiple global threats so far, that may be coming to an end.
I fully expect central bankers to try to push back against this evolving deflationary outlook before long. The European Central Bank meets on Thursday. The U.S. Fed meets Jan. 27-28. And the Bank of Japan meets on Jan. 28-29. We could hear more talk about easy money from the overseas banks, and the U.S. Fed could choose to sound a dovish note.
But it’s obvious that the markets don’t believe it’ll make any difference. So barring some kind of crazy, out-of-the-blue surprise, I doubt any banker-driven bounces will last very long or carry very far. In other words, stay cautious, stay safe, and stay prepared for more market downside over time.
Now, I’d love to hear from you. Is deflation winning the battle here? What does that mean for the economic or market outlook? Are you expecting central bankers to push back, and if so, what might they do? Will it have any impact? Use the comment section below to share your thoughts.
Many of you weighed in on the market outlook during the long weekend, discussing the lack of panic, the underlying economic conditions driving the recent declines, and more.
Reader James said: “The VIX hasn’t yet hit panic levels because retail investors have not largely even participated in the stock market’s rise over the last three years. The main thrust has been more fund managers, and mainly overseas money coming to the reliable U.S. markets.
“Soon enough there will be a relief rally for those wanting to get out to sell into. But the last year has been in a topping formation before the larger decline. No one ever knows for sure when or how large these events will take the market. But if I were to guess, the S&P 500 will close below the 1,870 area of support, and ultimately move to the 1,525-1,575 area sometime this late spring or summer.”
Reader Howard said: “For some time now in these columns I have noticed more players have anticipated a downturn. The reasons are many, but include lack of trust in the markets, dodgy figures, government intervention, Fed mismanagement and the expected end of a bull market.
“What was the catalyst this time? There are many likely suspects. But my money is on market manipulation, where the little guy is squeezed out in favor of the smart money playing the fear card.”
But Reader Tactical111 pointed to other drivers of the latest sell off, saying: “Haven’t you been paying attention to the global contraction and deflation trend? Like the article says, the commodities blood bath is leading the way. Market manipulation is always there and how we got the last six-year bubble by the way. Sooner or later, all bubbles pop and it looks like ‘later’ is finally here.”
Reader Gordon said the trick is to watch what’s happening on Main Street and what we’re hearing from Corporate America, rather than Uncle Sam. His take: “I quit believing in government and second-hand numbers long ago. Watch true numbers like the Baltic Dry Index, or Wal-Mart Stores (WMT) closing 269 stores and laying off 16,000 employees, or Microsoft (MSFT), Macy’s (M), and Caterpillar (CAT) laying off.
“These are real people losing their jobs, not a bunch of government baloney. Soon you will see a whole list of massaged numbers as corporations report their profits by hook or by crook — mostly crook — trying to keep damage at a minimum.”
Finally, Reader Ted F. said: “Prices have been way over-bloated for too long, with too much Fed funny money running around. It’s time for the market to return to reality. Something has to give.”
Thanks for sharing, and feel free to keep the discussion going below if you have anything else to add. These are tumultuous times, and none of my indicators suggest they that volatility is about to end. If anything, things are going to get even worse in the rest of 2016 — so you have to prepare your portfolio for that likely outcome.
Iran released a handful of American prisoners, including Washington Post reporter Jason Rezaian, over the long weekend. The release coincided with the lifting of sanctions against Iran, which will result in Iran boosting oil production and exports. The U.S. dismissed charges against some Iranians and commuted sanctions-related sentences in exchange for the prisoner releases as well.
The International Energy Agency (IEA) said that global crude oil supply could exceed demand by around 1 million barrels per day for the third year in a row. As a result, the market could “drown in oversupply” and continue to come under “enormous strain.”
Meanwhile, the International Monetary Fund (IMF) slashed its world growth outlook yet again. The group knocked 0.2% of its global growth forecast, lowering it to 3.4%. It also forecast deeper-than-expected recessions in Brazil and Russia, and projected GDP growth of only 6.3% in China — down from 6.9% in 2015.
What do you think of the Iranian-American prisoner swap deal? Will it help thaw relations even further — a long-term triumph for diplomacy? Or is it a sign of American weakness, as some critics say? What about the gloomy oil and economic growth forecasts from the IEA and IMF? Are they on target or too negative? Share your thoughts on these or other topics in the discussion section here.
Until next time,