April 5, 2017
Albert Edwards, the global strategist at Societe Generale who first predicted a long-term bond rally more than 20 years ago, said more gains loom as the Federal Reserve triggers another economic slowdown in the U.S. and resorts to massive monetary easing.
“Collapsing bank lending growth is signaling that something is amiss and the Fed should stop raising rates, but I expect rapidly rising wage inflation will push the Fed into overkill,” he said in an April 5 report. “Fed tightening cycles almost always end in recession and this time will be no exception.”
While the U.S. labor market is showing strength and first-quarter corporate earnings are estimated to rise 9 percent from a year earlier, the automobile industry is slumping and as Edwards points out, “bank lending to the U.S. corporate sector seems to have suffered some sort of seizure. It is difficult to know quite what to make of this, but it is typically associated with recession.”
Recessionary signals put the Fed in a difficult spot, as central bank officials have signaled their intention to raise interest rates three times this year. The stock market’s rise to record highs following the election of Republican Donald Trump on pledges to stimulate the economy with tax cuts and infrastructure spending was said to give the Fed room to hike borrowing costs.
The central bank cut rates to record lows in 2008 as the U.S. economy suffered its worst contraction since the Great Depression. The Fed also purchased trillions of dollars in government and mortgage debt as a way of driving down debt costs. The idea was to stimulate growth by encouraging borrowing among governments, businesses and consumers while punishing saving.
That central bank may have missed its chance to return to historical norms in monetary policy, Edwards said.
“The Fed should have tightened a long time ago as their easy money policies had unleashed another credit frenzy,” Edwards said. “But the latest data suggests the opportunity to normalize rates may have closed.”
Inflationary pressures, as seen in the consumer price index and wage growth, will compel the Fed to keep hiking, he said.
”For the Fed to tighten aggressively as bank lending slumps would be most odd,” Edwards said. “But tighten they will due to a rapid acceleration in wage inflation as high CPIs squeeze real wages in what is a tight labor market.”
Edwards has been on the record with bullish calls on the bond market since introducing his “Ice Age” thesis in 1996. The forecast advised investors to put money into bonds and be cautious with stocks as deflationary pressures like those seen in Japan spread throughout the world.
Japan has struggled with repeated recessions and slim growth since its economic bubble collapsed in the 1990s.
As another recession unfolds in the U.S., the Fed will have to buy more government debt, and drive yields on 10-year Treasurys to less than zero percent, similar to the monetary policies of Japan and the European Union, Edwards said.
“Bond yields may yet rise further, before the mother of all Ice Age rallies begins,” Edwards said. “As the Fed kills this recovery, expect U.S. 10-year yields to visit 3 percent before they converge with Japan and slump well below 0 percent.”