Expert Commentary

Deflation - The Word That Shall Not Be Named

Shakespeare's play Macbeth is reputed to be cursed having had dying actors and riots associated with various performances over the centuries. Saying the name Macbeth inside a theatre is thought to be very bad karma and so people refer to it as "the Scottish play" or "the Bard's play" to avoid the curse.

We're wondering whether the word deflation is going the same way as Macbeth. In a Bloomberg article, a leading bond fund manager stated, "It's likely we have a negative inflation print in the next few months..." Negative inflation? Is uttering the d-word now thought likely to result in disaster?

Well, I guess it might be a step in the right direction of acknowledging that rising and falling prices are not actually inflation and deflation. Inflation and deflation should strictly refer to the expansion and contraction of money and credit in an economy, but we have been conditioned to think only of consumer prices in this context. The fund manager in question is betting big that expectations of falling consumer prices, particularly over the next year, are too extreme. Another leading strategist for a large asset management firm states in an FT article: "When stay-at-home restrictions are removed, demand will roar back. Families will flock to restaurants, shops, shows, and mini-breaks -- anything but remaining in the homes they have been confined in. Households will, in many cases, have built up savings to fund such a binge."

We're very happy to take the other side of these positions. The stock market crash of March 2020, coming directly off high points in many markets, is most likely to be the start of a deflationary process rather than the end. Default rates are rising in credit markets and private sector debt deflation is underway. That, in itself, should keep downward pressure on prices, but consider this also - When the lockdowns do end, how does the excess retail stock that would have been moving now get shifted? The answer -- lower prices. How do travel firms entice people back to travelling? Lower prices. Discretionary items of consumer expenditure are being re-evaluated. As the chart below shows, the relative performance of consumer discretionary topped out in 2018, but has still probably only just started its decline versus staples.

The point is that social mood is changing to an outright negative trend where people are conservative and reticent. Social distancing is an ideal way to describe this new, post-virus, negative, deflationary trend.

200420 - MG