Expert Commentary

Fed – winter (deflation) is coming

As the world waits with bated breath for the final season of Game of Thrones, when the kingdoms unite against a terrifying enemy, the Federal Reserve might well see something similar.

Next month, television's first global blockbuster, Game of Thrones, airs its eighth and final season. The plot surrounds a Great War, when human enemies unite against the White Walkers, a terrifying army-of-the-dead who come from the frozen north. The chance of victory is slim as the White Walkers are relentless in destroying everything in their way.

The forces of deflation could be said to have the same effect, and the Federal Reserve may have just issued a call-to-arms.

Federal Reserve Chairman, Jerome Powell, remarked in the press conference after the recent scheduled meeting of the Open Markets Committee that weak global price pressures were "one of the major challenges of our time." Clearly, the Fed is concerned that price inflation remains subdued and has therefore decided to stop any hint of tightening monetary policy. Officials have decided to slow the Fed's Quantitative Tightening (QT) policy (drawing down its bond holdings accumulated through Quantitative Easing) starting in May, and then end the QT policy in September. QT didn't last long then (!) and the Fed's balance sheet is still bloated compared with pre-2008 levels. Could it be that the Fed are anticipating a coming Great War with the forces of deflation?

Perhaps. But it could also be preparing for another round of monetary easing by merely pointing the finger at its nemesis - deflation. "Look everyone, the White Walkers (deflation) are coming! We must make money cheaper and increase debt if we are to win the war." This is a ruse that central banks have used over and over again. They have created the myth that falling prices are bad for an economy, whereas history suggests that need not be the case. Debt-deflation has been coincident with contracting economies, but lower consumer or producer prices have often occurred in growth periods. Central banks and governments want us to believe that falling prices are bad so they can devalue the currency, increase debt and, therefore, increase the size of government.

So the Fed could be preparing the ground for Quantitative Easing 4. As EWI has highlighted on numerous occasions, though, the Fed always follows, never leads, and so its dovishness is not that surprising. The chart below shows that the U.S. Treasury 2-year bond now yields more than the 5-year bond, making that yield curve inverted. The record shows that such a phenomena has occurred a couple of years or so before U.S. economic recessions. No wonder the Fed fear that winter is coming.

190329 Deflation MG