The Deflation Myth

Deflation, Deflation, Deflation.

Central bankers around the world can’t seem to get enough of the D word. Deflation is rampant and needs to be purged, they say, justifying rate cuts and even negative interest rates.

Global Central Bank Policy Rates image

The U.S. Federal Reserve bucked the trend last December in raising rates to a paltry 25 bps (its first hike since 2006), and remains the only developed central bank in the world whose last move was a hike.

Since the December move, the Fed has refrained from hiking again, due in part to increasing fears of deflation during the market correction to start the year. During every correction, as long yields fall, the perma bear deflationistas come out in full force screaming of deflation and another Great Depression.

How accurate are these fears of deflation in the U.S? Let’s take a look at the data.

1) Looking at the US CPI data, inflation is running about 2.2% (core, excluding food/energy) and 0.9% (overall, including food/energy) over the past year.

US CPI data image

2) Looking at US Personal Consumption Expenditures (PCE) data, inflation is running at about 1.7% (core) and 1.0% (overall) over the past year.

Image of Fed Funds Effective Rate vs US PCE Core vs US PCE Deflator

3) Looking at Owners Equivalent Rent, the largest component of CPI, it is running at 3.1% over the past year.

US Owners Equivalent Rent graph

4) Average hourly earnings in the U.S. are up 2.3% over the past year.

Image of US average hourly earning from 2007 to 2016

5) Market-based inflation expectations (breakevens calculated from TIPS minus nominal) are currently running at 1.45% to 1.65% over the next two to ten years.

Market-based inflation expectations image

Inflation and expectations for future inflation are certainly lower than the historical average, but this is not deflation. Prices are still rising overall, as anyone who pays the bills for food, housing, healthcare, and education will tell you.

In fact, if we look at the historical inflation data going back to 1960, we have never seen outright deflation in the United States. Yes, it has been trending lower over this time, but it is still positive.

US inflation data from 1960 to 2016

This is interesting as it pertains to the markets today. There seems to be an increasingly vocal view that the U.S. will eventually go the way of Europe and Japan, pursuing negative interest rate policy and currency debasement.

Image of race to negative bond yields

While anything is possible, I don’t believe this is probable in the near term as I wrote back in February (“The Easy Money Game Has Changed”).


Because the easy money game changed back in December with the first rate hike in seven years. The Fed wants to normalize interest rates as they recognize that there are serious untended consequences to keeping rates at artificially low levels for an extended period of time. They also likely recognize, if they are honest about the data. There is no actual deflation in the U.S. to justify the extreme measures of the ECB and the BOJ. To shift from the path to normalization, then, would require a severe stock market downturn and another recession at a minimum.

As far as I’m concerned, Europe and Japan can have their negative interest rates. I’d much prefer higher interest rates accompanied by higher growth; yes, the two are related as you can see in the chart below (click here for our research on Treasuries).

US nominal GDP graph

As for the U.S. economy, Jobless Claims hit their lowest level since 1973 this week. Given this backdrop, the notion that a 25 bps Fed Funds Rate is holding back growth seems a bit absurd. This is still extraordinarily easy monetary policy.

Initial jobless claims and fed funds rate image

As for the equity markets, the S&P 500 (total return) hit new highs this week, not a backdrop suggesting a need for additional monetary stimulus. The one thing missing from my silver linings playbook piece penned at the February lows? Higher long duration yields, and a steeping yield curve.

US yield curve from 2008 to 2016

The question for investors today:

Are long yields being held down by the extreme policies of Europe/Japan or a real concern about growth in the U.S.? Given the rise in inflation expectations in recent months, it would seem to be more of the former. If that’s indeed the case, long bond yields should start to rise from here and the Fed will be inclined to continue normalization in the coming months.

As for the pundits screaming about deflation and depression without any data to support that view? Ignore them at all costs.


This writing is for informational purposes only. It does not constitute an offer to sell, a solicitation to buy, or a recommendation regarding any securities transaction. It also does not offer to provide advisory or other services by Pension Partners, LLC in any jurisdiction in which such offer, solicitation, purchase or sale would be unlawful under the securities laws of such jurisdiction. The information contained in this writing should not be construed as financial or investment advice on any subject matter. Pension Partners, LLC expressly disclaims all liability in respect to actions taken based on any or all of the information on this writing.



Charlie Bilello is the Director of Research at Pension Partners, LLC, an investment advisor that manages mutual funds and separate accounts.  He is the co-author of four award-winning research papers on market anomalies and investing. Mr. Bilello is responsible for strategy development, investment research and communicating the firm’s investment themes and portfolio positioning to clients. Prior to joining Pension Partners, he was the Managing Member of Momentum Global Advisors. He previously held positions as an Equity and Hedge Fund Analyst at billion dollar alternative investment firms.

Mr. Bilello holds a J.D. and M.B.A. in Finance and Accounting from Fordham University. He has also done a B.A. in Economics from Binghamton University. He is a Chartered Market Technician (CMT) and a Member of the Market Technicians Association. Mr. Bilello also holds the Certified Public Accountant (CPA) certificate.


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