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Time to Bid Farewell to Inflation?

Image: Time to Bid Farewell to Inflation?

By Edward Yardeni
Monday, 19 Jun 2017 08:37 AM Current | Bio | Archive

No one knows whether Amazon women ever existed. These warrior women were first mentioned by ancient Greek poet Homer in the Iliad, set during the Bronze, or Heroic, Age. He referred to them as “antianeirai,” meaning “those who go to war like men.” Ancient Greek historian Herodotus describes them as “androktones,” meaning “killers of males.” The name “Amazon” is believed to come from the Greek word “amazoi,” which means “breast-less,” as young female warriors’ right breasts were removed to facilitate their drawing of the bow, according to legend. Besides bows and arrows, their main weapon, Amazons wielded swords and double-sided axes while carrying a distinctive crescent-shaped shield. Most of their fighting was done from horseback.

Could Jeff Bezos be Amazon Man? He certainly has the killer instinct, and continues to slaughter his competitors. Jackie and I have been following his exploits for some time and have concluded that he is also killing inflation. He has brought deflation to the book industry, mall retailers, and the cloud. Now he is doing the same to grocery stores, with the biggest losers likely to be their vendors, i.e., manufacturers of consumer brands, particularly staples.

Bezos is not alone in his battle to disrupt and destroy business models, with deflationary consequences. Elon Musk is also an Amazon Man, who intends to harvest solar energy on the roofs of our homes, storing the electricity generated in large batteries while also charging up our electric cars.

Meanwhile, the frackers are using every frick in their book to reduce the cost of pumping more crude oil. Pharmaceutical companies are under lots of political pressure to stop hyper-inflating drug prices. Telecom services prices are falling as a result of intense competition. With price inflation remaining subdued, it’s no wonder there isn’t a lot of upward pressure on wage inflation even though the labor market is obviously very tight.

Consider the following:

(1) Disinflation. On a y/y basis, the headline and core CPI inflation rates both fell back below 2.0% (the Fed’s target for the PCE price deflator) in May to 1.9% and 1.7% (Fig. 1). On a three-month basis and annualized, they were -1.0% and 0.0% through May (Fig. 2). Showing outright deflation on a y/y basis are wireless telephone services fees (-12.3%), used car prices (-4.3), airfares (-2.9), and furniture & bedding (-1.4) (Fig. 3 and Fig. 4). Even the medical-care CPI inflation rate has dropped from a recent high of 4.9% to 2.7% in May, led by falling inflation rates for physician services and even drugs (Fig. 5).

(2) Food fight. Online shopping now accounts for a record 29.7% of GAFO sales (i.e., sales of goods typically found in department stores) (Fig. 6). That’s up from about 5% in 1992. It was 9.0% when Amazon went public during May 1997. The company clearly has taken lots of growth and market share away from the department stores. It’s been doing the same to the warehouse clubs and super stores since 2009.

Now Bezos is going after the grocery business. It’s a huge one, with sales totaling a record $939 billion (saar) during April. The warehouse clubs and super stores have increased their share of this business from 7.0% in 1992 to a peak of 27.2% during June 2008 (Fig. 7). That share was down to 23.8% during April, and is likely to continue falling as Amazon Man enters the fray. Bezos plans to do so by purchasing Whole Foods and using its stores as fulfillment centers for food sold by his company online, with the assistance of voice-activated Alexa.

(3) Drowning in oil. OPEC oil producers continue to put a lid on their output in an effort to prop up prices. Yet the price of a barrel of Brent crude oil is back down to $47.37, below its recent high of $57.10 on January 6 (Fig. 8). That’s comfortably in the $40-$50 price range that Debbie and I have been expecting for this year. Despite the 76% plunge in the price of oil from June 19, 2014 to January 20, 2016, US crude oil production fell just 12% from the week of June 5, 2015 through the week of July 1, 2016 (Fig. 9). Since then, it is up 10% to 9.3mbd.

Interestingly, weekly production held up relatively better in Texas and North Dakota than in the rest of the country when total output was declining (Fig. 10). However, the rebound in US oil production has been led by the rest of the country, excluding Texas and North Dakota. Could it be that frackers figured out how to lower their costs in the two states where they’ve been most active, and taken their innovations to the other states? Maybe.

Meanwhile, the 52-week average of gasoline usage in the US is down 0.7% y/y (Fig. 11). This may or may not be a sign of a slowing economy. It is undoubtedly a bearish development for oil prices.

Saudi Arabia, Russia, Iran, and other major oil producers, with large reserves of the stuff, should be awfully worried that they are sitting on a commodity that may become much less needed in the future. As long as the sun will come out tomorrow (as Little Orphan Annie predicted), solar energy is likely to get increasingly cheaper and fuel a growing fleet of electric passenger cars. Rather than propping up the price, maybe they should sell as much of their oil as they can at lower prices to slow down the pace of technological innovation that will eventually put them out of business.

(4) Bond vigilantes. The bond market certainly confirms that the disinflation story remains a credible one. The yield spread between the US Treasury 10-year bond and its comparable TIPS is deemed to be a measure of inflationary expectations over the next 10 years. It soared following Election Day, from 1.73% on that day to a recent peak of 2.08% on January 27 (Fig. 12). It was back down to 1.67% on Friday, the lowest since October 24. The yield curve spread between the 10-year bond yield and the federal funds rate has narrowed from a recent high of 213bps on December 14, 2016 to 100bps near the end of last week, the lowest since July 8, 2016 (Fig. 13).

There is mounting concern that the bond market may be signaling that even slower economic growth is ahead. Perhaps. More likely, in our view, is that long-term bond investors are coming around to our view that inflation may be dead. There are some very powerful structural forces that should continue to keep it from rising from the dead. If so, then the bond vigilantes can relax.

(5) Deflationary drivers. Intensifying competition, technological innovation, and aging demographics are the structural forces that are keeping inflation in check. They’ve done so despite the ultra-easy monetary policies of the major central banks. Here is a brief list of some of the main events that have broken the back of inflation, which is likely to remain flat on its back: Walmart goes public (August 1972), Volcker clobbers inflation (October 1979), Reagan fires PATCO (August 1981), the end of the Cold War (November 1989), Amazon goes public (May 1997), China joins the WTO (December 2001), Amazon Web Services opens the cloud (August 2006), the oldest Baby Boomers turn 65 (January 2011) (Fig. 14).

Dr. Ed Yardeni is the President of Yardeni Research, Inc., a provider of independent global investment strategy research.

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With price inflation remaining subdued, it’s no wonder there isn’t a lot of upward pressure on wage inflation even though the labor market is obviously very tight.
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