Wednesday, November 19, 2014

The Challenges of Global Disinflation

Above we can see the collapse of commodity prices over the past six months, as reflected in the Goldman Sachs Commodity Index (GSCI); oil futures; the gold ETF (GLD); and wheat futures.  In an inflationary environment, we expect to see rising commodity prices and a weak currency.  What we've see of late is a strong U.S. dollar and falling commodity prices:  a much more disinflationary environment.

Indeed, disinflationary forces have emerged as a key concern at the Bank of England and the Bank of Japan sounds less clear that it can reach its 2% inflation target.  We are also hearing recent reports of "entrenched" disinflation across Asia.  Falling commodity prices are also disinflationary for producers of raw materials such as Australia.  Across much of the world, disinflation has taken hold of economies, and that has included the U.S.

So what happens in a world of growing disinflation?  We see competitive devaluations of global currencies to stimulate inflation, with Europe seemingly following the recent lead of Japan.  Risk-free yields remain crushed in a disinflationary world of zero interest rate policies, encouraging yield-seeking through stocks and longer-duration bonds.  That has been very good for the long stocks/long bond trade.

With the much stronger dollar and G20 promises of more economic stimulus to come, will global economies pick up some of the strength of the U.S. economy (which has benefited from lower commodity prices and restrained rates), or will that strong dollar become an anchor to the U.S. economy, restraining overseas demand for U.S. goods and forcing the U.S. to join the competitive downward race?  I will be watching the relative performance of overseas equities markets to the U.S. stock market; the behavior of U.S. and overseas rates; and the forward trajectories of commodities as ways of handicapping this key issue.