Expert Commentary

And Now, Deflation Reality Dawns

As market volatility picks up again, the true extent of the problem is emerging.

The debates will last for years as to how we got to this point, but the fact is, most developed economies are in dire straits. The lockdowns have resulted in disaster for many businesses large and small, whilst the survivors have found that they have had to take on a huge extra debt burden just to stay afloat. As lockdowns ease and people decide what to do, the next few weeks are going to be crucial in determining whether the economy recovers or implodes. Given the Elliott Wave outlook at this juncture, we’re erring towards the implosion side of things.

Banks are increasingly becoming the focus, which is what we would expect in a debt deflation. Britain’s financial regulator, the Financial Conduct Authority (FCA), has warned U.K. banks that they will need to find an entirely new way of dealing with personal and business debt. It’s not exactly clear what that means, but it doesn’t take a genius to see that the FCA, despite lending not being in its normal job function, is urging banks to effectively “go-easy” on those that have taken on extra debt. That may mean rolling over existing credit agreements without penalizing borrowers, something that U.S. banks are already doing. That same leniency is being applied in the corporate bond market with some lenders allowing profits to be rolled over from 2019 to avoid breaches of covenants.

U.K. banks have warned that up to half of the £18.5 billion advanced under the “bounce back” loan scheme is unlikely to be repaid as they expect hundreds of thousands of small businesses to collapse. As the bank executives are all too aware, pursuing these debts through the courts would be a PR disaster. Debt deflation appears inevitable in the U.K. and the latest data on price changes, as the chart below shows, is also blowing the way of deflation.

Smoothing out terms for borrowers (aka: kicking the can down the road) will mean that the real level of debt default may not be known until bank reports in the third or fourth quarter this year. Markets may already be anticipating that the news will be very sobering.

U.K. Consumer Price Index