Inflationary fears could soon return

From Justin Brill, Editor, Stansberry Digest:

Yesterday, a Wall Street Journal report highlighted what regular Digest readers have known for months…

Inflation is quietly ticking higher across most of the world’s major economies. From the report…

After years of fighting against deflation, the U.S., the eurozone and Japan show glimmerings of life in consumer prices and wages, evidence that an era of exceptionally low inflation is receding from the global economic landscape…

“There are inflationary mechanisms rather than disinflationary mechanisms or deflationary mechanisms in place now,” said Ian Shepherdson, chief economist at research firm Pantheon Macroeconomics. He pointed to stabilized global energy prices, rising prices for factory goods coming out of China, and a low U.S. unemployment rate set to drive an acceleration in wage growth.

The Journal also noted that recent events could make central banks – particularly those in Europe and Japan – reluctant to raise rates or withdraw stimulus too quickly. More from the Journal

Though inflation is now practically at the ECB’s target rate of around 2%, the central bank has shown no sign of paring its stimulus…

The ECB has a recent history of raising interest rates prematurely as inflation picks up. In both 2008 and 2011, the central bank began to increase rates, only months before reversing its policies and cutting rates once again.

It’s a similar story in Japan, whose economy has fallen in and out of deflation for years. Even here in the U.S., Federal Reserve officials still reference their belief that the Great Depression of the 1930s was prolonged by tightening monetary policy too soon.

In other words, after years of battling deflation with unprecedented stimulus, central banks could be unwilling to react to inflation until it’s clearly moving higher again… And by then, it could quickly get out of hand.

We’re not alone in this concern…

Billionaire investor Paul Singer – whose Elliott Management hedge fund earned 14% annual returns for a remarkable 35 straight years – is also concerned about the risks of higher inflation. From Elliott’s latest letter to investors this week (emphasis added)…

There is a deep underlying complacency which we think permeates global financial markets. The basically-low volatility of the last eight years has led to a widespread assumption that financial market volatility has been bottled and will remain controlled.

Moreover, despite the radical monetary policy which has become orthodoxy for the entire developed world’s central banks, there is no fear of a near-term eruption of significant systemic price inflation. It is a fool’s errand to predict the near-term course of inflation (and global central bankers and policymakers have failed miserably and continuously in performing this errand), but we believe that the global confidence in the placidity and boundaries of inflation (and global financial risk) is misplaced and overdone…

It will be interesting to watch. If inflationary expectations get rolling, it might be amazing how quickly they take hold. “Very quickly” would be in rough alignment with the magnitude of the monetary extremism of the post-GFC period, but there is no way to predict exactly how it will all play out.

This is one more reason we continue to recommend gold and silver…

This environment would be incredibly bullish for precious metals. And of course, it would be incredibly bearish for bonds…

This is because longer-term interest rates tend to rise with inflation, as investors demand higher yields to compensate for the loss of purchasing power. (Remember, bond prices fall as interest rates rise.) And today, bond investors are more exposed to the risks of higher interest rates than at virtually any time in history. If inflation begins to rise significantly, bonds will plummet.

Stocks will likely do well, too… at least for a while. As we’ve discussed, history suggests rising inflation should be bullish for equities initially. But as long-term rates pass a “tipping point” – approximately 5%, according to JPMorgan Asset Management – higher yields can begin to act as a “magnet” that draws money out of stocks.

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