Fears of deflation are starting to stalk financial markets, especially in the US.
Investor confidence in Australia and the US in some of our leading companies has suddenly become very delicate, helped of course by the shorts.
The plunge Wednesday night on Wall Street came mostly after the release of the Fed’s minutes of its last meeting which cut rates to 1%, but raised the prospect of price deflation: before that the CPI for October had echoed the producer price movement for the same month and fallen by a record.
Overnight Thursday the S&P 500 slid 6.7% to 752.58, under the low of 776.76 reached during the bear market in 2002.
The Index extended its 2008 tumble to 49% and is poised for the worst annual decline in its 80-year history.
The S&P 500 extended its plunge from an October 2007 record to almost 52 percent in the worst bear market since the Great Depression.
Bloomberg said that concern the recession is worsening was spurred after jobless claims approached the highest level since 1982, (542,000 new claims were lodged in the US last week.
The index of leading economic indicators fell for a third time in four months and the Federal Reserve said manufacturing in the Philadelphia area shrank at the fastest pace in 18 years.
Seventeen companies in the S&P 500 lost more than one-fifth of their market value today, as all 10 of the index’s main industry groups slid at least 3.5%.
Interest rates fell sharply, oil went under $US50 a barrel in New York and riving this the fear of slowdown and possible deflation next year.
The day before the core CPI was down 0.1%. The falls in the headline numbers (minus 1%) for it and the producer price index, were the largest since records were started back in 1947.
US investors are getting a glimpse of what 2009 could look like: badly recessed (the new home starts and building permits fell to their lowest levels since 1947 as well in October) and deflated as prices fall sharply into negative territory and consumers and business cut purchases because they know things will get cheaper.
Already we are seeing that the real market Federal Funds rate isn’t the official 1%, but well under that, around 0.3% on some days. Three month US treasury note yields fell to 0.015%, but that’s not yet a record low: that was 0.0% in September when Lehman Brothers collapsed.
With prices deflating, it means that interest rates will be high (in relative terms) and monetary policy will be restrictive, which in turn is bad news.
For years the big watchword was "inflationary expectations".
Well, according to more and more economists, "deflationary expectations" are in danger of taking hold in the US, just as they did for years in Japan from 1990 onwards.
It’s a horrible expectation: consumers hold back purchases (as do companies) so retailers and others start discounting their selling prices to get business; consumers refuse to buy, so the discounts become bigger.
Wednesday’s consumer price figures showed the falls in almost all categories of discretionary spending. A headline fall of 1% in the month. The largest ever. Core inflation down 0.1%, a surprisingly large fall.
The Fed said this in its minutes of its last meeting:
"The pace of economic activity appears to have slowed markedly, owing importantly to a decline in consumer expenditures.
"Business equipment spending and industrial production have weakened in recent months, and slowing economic activity in many foreign economies is damping the prospects for US exports.
"Moreover, the intensification of financial market turmoil is likely to exert additional restraint on spending, partly by further reducing the ability of households and businesses to obtain credit."
As consumers account for around 70% of US economic activity, the Fed is worried. Inflation is no longer a curse, but a virtue.
On inflation, the Fed said "Inflation was likely to diminish materially" in coming quarters but there was disagreement about whether it would fall to dangerously low levels.
"Participants generally expected inflation to decline to levels consistent with price stability.
"Others, though, saw a risk that if resource utilisation remained weak for some time, inflation could fall below levels consistent with the Federal Reserve’s dual mandate for promoting price stability and maximum employment, a development that would pose important policy challenges in the light of the already low level of the Committee’s federal funds rate target."
In other words, price deflation and the possibility of a very restrictive monetary policy, that will further constrain inflation and the level of activity.
There now seems to be a belief emerging that next year will be worse than forecast.
Instead of the depth of the slump being felt this quarter (US growth is forecast to contract by 3% or more according to Bloomberg and other surveys), there won’t be much of a change in 2009.
Worries about the possible collapse of the US domestic car producers, GM, Ford and Chrysler added to the problems. Queries are again being raised about the health of some banks.
So 14 of the S&P 500 stocks had falls of 20% or more in their shares prices on Wednesday: one of the biggest losers was Berkshire Hathaway, Warren Buffett’s company.
It has had a bad time since reporting a 77% plunge in third quarter earnings, thanks to lower returns from insurance and the markets.
But suddenly there’s a touch of tarnish around the market’s talisman: Berkshire shares fell by their biggest amount in 23 years Wednesday: down $US11,500 to $US84,000. T
