Tuesday, January 21, 2014

Deflation, Bonds, & Stocks (excerpt)

All the recent chatter about deflation has been good for bonds, especially in the Eurozone’s peripheral economies. The 10-year government bond yield in Spain has declined 42bps since the end of last year to 3.7%. Italy’s comparable bond yield has done the same, falling to 3.8%. Both are back to the lows of 2010. That’s because the ECB is expected to inject more liquidity into the banking system in response to the decline in the Eurozone’s core CPI inflation rate below 1% since October. The core CPI inflation rate is higher in the US, at 1.7% through December. But the core PCED was lower, at 1.1% through November. Since the end of last year, Treasury, corporate, and muni bond yields all have edged lower by 15-23bps.

Initially, deflation might actually be bullish for stocks, even causing a melt-up. That’s because central bankers are already talking about the need to act decisively now to avoid it. Another round of ultra-easy monetary policies would surely cause stock prices to soar. If deflation prevails nonetheless, the melt-up would be followed by a meltdown, worsening the deflation. In general, falling consumer prices would be bad for corporate earnings. However, companies that are able to maintain some of their pricing power and earnings growth in a deflationary environment would certainly be highly valued.

Today's Morning Briefing: Deflation Scare. (1) The deflation mandate. (2) Long waves of inflation and deflation. (3) Why do central banks dread price deflation? (4) Can price deflation cause asset inflation? (5) The Rhythm of History. (6) Good vs bad deflation. (7) Bullish for bonds. (8) Asset classes and deflation. (9) Deflation hits retailers. (10) Disinflation bordering on deflation in Eurozone and US. (11) “Nebraska” (+ +) and “August: Osage County” (+ +). (More for subscribers.)

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