SocGen’s Edwards: Deflationary ‘Quagmire’ Will Spur More Fed Stimulus

November 24, 2014

The Federal Reserve faces a much tougher decision on whether to raise interest rates next year as consumers expect the pace of price increases to slow.

That’s the message from Albert Edwards, a strategist at Societe Generale who says “the unfolding deflationary quagmire into which we are sinking will get worse and there will be more Fed QE.”

QE stands for “quantitative easing,” a term to describe the central bank’s attempt to jumpstart the economy by buying of trillions of dollars of debt to keep borrowing costs for businesses and consumers at record lows. The Fed shut off the money spigot last month, but has yet to raise interest rates. Bond investors expect rates to rise in the middle of next year.

Edwards is concerned that people have scaled back their inflation outlook even as they feel better about the economy.

Consumer sentiment rose a seven-year high this month, according to the Reuters/University of Michigan Consumer Survey. At the same time, expectations for one-year inflation fell sharply to an average of 2.8 percent in November from 3.5 percent a month earlier. The median measure slumped to 2.6 percent from 2.9 percent.

Inflation expectations “have fallen to levels associated with extreme equity and bond market turbulence,” Edwards said in a Nov. 20 report obtained by “To paraphrase Hamlet: Something is rotten.”

The core U.S. consumer price index, which excludes moves in energy and food prices, “remains persistently weak,” Edwards said. “If this is an upcycle, this is as good as it gets.”

Don’t Blame Oil

Edwards dismissed the idea that the decline in oil prices to a four-year low is responsible for the slide in inflation expectations. Instead, he attributed the decline to consumers who have scaled back their estimates of rapid price increases resulting from the Fed’s monetary largesse.

“There were quite a few hold-outs who believed Fed QE would cause very rapid, if not hyper, inflation,” Edwards said. “An alternative explanation might be there were previously no outliers who saw Japanese-style deflation, and now there are more.”

Dallas Fed President Richard Fisher said he is comfortable with inflation above 2 percent, according to the Financial Times. Inflation most recently fell to 1.7 percent from more than 2 percent in June.

“I don’t see [inflation risks] right now. I can see us lifting up gradually to the 2 percent target. I can see us even running over that for a little while,” he said to the newspaper.

Fisher is considered one of most hawkish members of the Fed’s monetary policy committee, pushing for a rise in interest rates before his colleagues have. He plans to retire from the central bank in March.