There are increasing signs that deflationary forces are having an effect.
The most recent Consumer and Producer price data for the U.S.A. show that price rises are slowing. Consumer Price Index (CPI) data shows an annual inflation rate of 1.9% (including food and energy) in December 2018. That's down from 2.2% in November and 2.9% in July. The Producer Price Index fell by 0.2% in December, surpassing expectations of a 0.1% drop, leaving the annual rate at 2.5%. That's down from an annual growth rate of 3.4% in July 2018. The data is warning of a new disinflationary trend in prices.
This shouldn't come as a shock of course. Price inflation expectations, as measured by inflation-protected bond "breakeven rates" peaked out in May 2018 and collapsed with the equity and credit market rout in the fourth quarter. Social mood is turning negative and that means attitudes towards debt are changing too. Leveraged loans and junk bonds are imploding in what could be the start of a more serious debt deflation.
The negative turn in social mood is the real driver of the disinflationary trend but we can't ignore the 600-pound gorilla in the room -- the Federal Reserve balance sheet. As the chart shows, having held steady from 2016 to the end of 2017, the Fed's balance sheet really started to shrink in 2018. As we have pointed out previously, this is a deliberate policy of deflation by the Fed. Increasing the balance sheet was considered to be a stimulus by creating more money (inflation). The Fed is now withdrawing liquidity which is monetary deflation.
If EWI's expectation that a continued negative trend in social mood will drive the stock market and the economy lower is correct, we fully anticipate that the Fed will seek to reverse this deflation policy in an attempt to prop up the economy à la 2008-09. Back then, a natural upturn in social mood allowed the Fed to be seen as the saviors of the day. This time, with the negative trend in social mood being of higher degree, the Fed will probably not be so lucky.