Is Central Bank Reflation, Deflationary?


Alan Greenspan, aka The Maestro, used a playbook whereby the leaky economic balloon was reflated with hot air. Unfortunately, tools like money supply, target funding costs, and quantitative easings are blunt, struggle to repair holes in economic performance, and may cause or reinforce more threatening deflation.

In general, more cash for future purchasing power and opportunistic selection in bear-market sectors as well as holding high quality income-producing stocks (in-particular, defensives) and bonds may offset some of the macro pain. Lowering debt service and managing liabilities is wise, too; however, an outright deflation scare in the headlines and Fed Minutes is probably an all bets are off scenario.

Structural issues often fly in the face of central banks’ best laid plans to stimulate growth and inflation. Demographic shifts, technology, financial market infrastructure and liquidity, and malfunctioning political and economic systems move more swiftly to impact product demand, employment, asset allocation decisions, productivity, and collaborative trade. Legal, social, health, and cultural changes can shift economic performance through regulatory barriers, buying patterns, and human activity. A central banker may temporarily reflate a wounded balloon; however, it will deflate again unless the structure is repaired.

Too much reflation can further damage the economic balloon!

Reflation strategies can weaken infrastructure via destabilization of “normal” economic cycles and relationships. Market participants may be forced into misguided behaviors; for example, income investors reaching for yield in junk bonds, Puerto Rico municipal bonds, and Energy MLPs. Part of the reflation strategy is to stimulate prices in risky assets (like stocks) and thereby cause a “wealth effect” of spending throughout the economy. This activity can cause overvaluation which leads to behavioral missteps in areas such as asset allocation, use of margin, and securing collateral accounts.

Unprecedented global reflation is deflationary if market participants and consumers delay purchase, construction, and investment activity with the expectation that cheap money and still lower prices will occur in the future. Perceived current investment risks, fear of a collapse in liquidity, and actual bursting of bubbles or balloons reinforce deflationary pressures.

Global central banks, led or steered by Mario Draghi, Abe Shinzo, and Xi Jinping, are repeating a risky playbook rekindled under Ben Bernanke. 

A tour around the globe just before Halloween reveals lower and even negative interest rates (Germany, France & Italy), low to zero inflation, falling commodity prices, decelerating production and demand, insufficient gross domestic production in every major economy, and weakening aggregate revenues and profit margins. Gloomy, right?

The United States is often cited as the best global performer: See below for a graphical look at the U.S. FOMC preferred PCE inflation indicator, U.S. 10-Year Rates, WTI Oil Prices, and Manufactures’ New Orders. Even the globally exposed S&P 500 constituents have seen 2015 bottom-up operating earnings estimates retreat from $131 to $110 since December 31, 2014.

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Proactive supervision and comprehension of the factors that impact your hard earned wealth and probability of meeting unique goals is essential. Perhaps no action is necessary; however, mental preparation for the price volatility discovered on your statements makes for better investing.

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Michael loves to empower investors with his expertise in securities and economic analysis, goals-based wealth management solutions, and FinTech smart decision-support tools. While directly managing over $5 billion in growth and retirement assets; his proactive advice and software innovations have influenced thousands of fiduciary advisors to better their practices and service to clients. He enjoys spending time with his wife and three boys, competing in USTA tennis, and mentoring others to succeed.

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