Although everyone is talking about inflation right now, when we look at developed markets, we see reason to believe that 2009 in fact heralds a period of deflation. After all, when you strip out oil and food prices, there is not much inflation around. For example, core inflation in the US has remained steady at 2.3% y-o-y, and has in fact trended down from a high of 2.9% in September 2006, and 2.5% at the start of 2008. In fact, since the beginning of the year, aside from the spike in energy and food prices, the following factors are hardly conducive of higher interest rates.

1. The S&P has declined by over 20%.
2. The S&P/Case Shiller Composite-20 city home price index dropped by 15.3% y-o-y as of end-April, while anecdotal reports suggest house prices in certain areas of the US have fallen by as much as 50% from their highs. New home sales, for example are at a 17-year low.
3. Unemployment has crept higher to 5.5%, which will steer wage pressures downwards.
4. Credit is now much harder to come by, for industry and consumer alike. Three-month deposit rates are trading some 120bps above the Fed funds rate, despite central bank easing.
5. As a result consumer confidence is at record lows, while real GDP growth will fall below 1.0% y-o-y for 2008.
6. All of the above is leading to aggressive discounting in the shopping mall.

Hardly inflationary, is it? Similar factors, of course, apply to the UK, euroland, and Japanese economies (Japan’s ‘core-core CPI’, which includes both fresh food and energy prices, is still slightly negative). When combined with an almost certain slowdown in Emerging Market economic activity, on the back of further monetary tightening, we reiterate our view of demand for commodities decreasing to such a degree as to trigger a sharp correction in oil and grain prices. When this happens, we are left with a world of rapidly falling prices.

Tags: Commodities, consumer confidence, credit, deflation, developed markets, energy prices, food prices, grain prices, inflation, oil prices, real GDP growth, S&P/Case Shiller Composite 20, unemployment
Posted in: General, Inflation/Deflation
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