jueves, 15 de enero de 2015

jueves, enero 15, 2015
The global deflation shock – how big and how bad?

Gavyn Davies

Jan 11 16:32


The Brent oil price has fallen by a further 9.3 per cent in the first few days of 2015, making the total decline since mid 2014 a remarkable 56 per cent. With Saudi Arabia showing very little sign of restricting supply, economists have been scrambling to reduce their global inflation forecasts in line with the new reality in the oil market.

For investors and central bankers, two questions are dominating discussion – how much deflation will be seen in 2015, and how severe a threat does it pose to the health of the global economy? The answers are complex, because deflation is occurring simultaneously in two different varieties.

The first is “good” deflation, stemming from the huge beneficial supply shock from oil. But the second is “bad” deflation, stemming from a persistent shortage of aggregate demand in the developed economies, especially the eurozone.

At present, good deflation is definitely dominating the global picture, and this is being priced into asset markets. But the threat from bad deflation in the eurozone is still rumbling away in the background.

How low will inflation go in the next few months? The impact of lower commodity prices will be to reduce global inflation by about 1.2 per cent, and to reduce inflation in the developed economies by 1.6 per cent. According to Bruce Kasman at J.P.

Morgan (who says he has “learned to stop worrying and love deflation”), global inflation, including the emerging markets, will drop to below 1 per cent in the middle of 2015, the lowest reading outside a recession in the past 40 years. In the developed economies, headline inflation will be negative for much of the year.



The impact of lower oil prices on headline inflation in the US is particularly large, reflecting the relatively high energy intensity of the US economy, and the low levels of energy taxation. With Brent oil at $50/barrel, the US headline CPI index will be reduced by about 2.2 per cent, compared to the period immediately prior to the oil shock.

The first graph shows the latest Fulcrum estimates for US inflation. The 12 month headline inflation rate will drop to a low point of -0.4 per cent in July.

However, the period of outright deflation is likely to be relatively short-lived, provided that oil prices stabilise, and provided the impact on core inflation (ex energy) is relatively minor. Headline inflation should move back into positive territory in 2015Q4, and then automatically return to its underlying rate of 1.5-2.0 per cent early in 2016.

The US deflationary shock will therefore be sharp, but very temporary, and good deflation will clearly be in the ascendancy. Interestingly, the Atlanta Fed’s estimate of the probability of deflation becoming endemic in the period up to 2018, derived from the index linked bond market, remains at precisely zero.



In the eurozone, however, the numbers look rather different. The impact of lower oil prices will be to reduce the headline HICP index by about 1.0 per cent, less than half the size of the impact in the US. However, because the headline inflation rate prior to the shock was already running as low as 0.5 per cent, the oil shock will still take it into negative territory for a prolonged period.

In fact, headline inflation in the eurozone has already fallen to -0.2 per cent in December 2014, and it is now likely to track at about -0.4 per cent for much of 2015, returning to around 0.8 per cent in early 2016. This assumes that ex energy inflation tracks at around 0.5 per cent, close to where it has been in recent months. Unlike in the US, “bad” deflation has been taking hold in the eurozone since 2013 (see the blue line in the graph). The great concern for the ECB is that good deflation will now unhinge price expectations, making bad deflation even worse.

What will be the impact of this decline in US and eurozone inflation on the global economic outlook? After much debate, a consensus is now emerging that the decline in price inflation, with wage inflation remaining roughly unchanged, will result in a major boost to real consumers’ expenditure in the developed economies.

According to J.P. Morgan, this is already clearly visible in the data, with real retail sales in the developed economies now growing at an annualised rate above 3 per cent. Growth in real consumers’ expenditure should touch 5 per cent in the US in coming quarters, and it may reach 2 per cent in the eurozone.

This is now beginning to impact industrial production, which is rising at an annual rate of 3.5 per cent in the developed economies.

There will admittedly be negative effects on investment in the energy sectors, notably in the US. But an excellent World Bank report published last week estimates that real global GDP in the medium term will gain by about 0.5 per cent, assuming that oil prices drop by 30 per cent. With the much larger drop in oil prices now in the markets, the boost to global output could be closer to 1 per cent. Note that this is a permanent gain to the level of output, for as long as oil prices remain at present levels.



This relatively sanguine assessment of the deflation shock is increasingly being priced into the financial markets. Although a lot of economic commentary has focused on the dark side, especially since bond yields have tumbled to new lows, the markets have actually reacted in a rational manner to the greater weight on good deflation, compared to bad deflation, since the middle of last year.

This shock should have been good for non oil equities, which have indeed risen by 6 per cent, and bad for the energy sector, where stock prices have fallen by 15 per cent. Reduced inflation should have brought down 10 year government bond yields, which have indeed fallen by 50 basis points. And the rise in the dollar also looks rational, given the relative absence of bad deflation in the US.

Financial markets often misread economic fundamentals, but I think not this time.

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