Question: “I’ve long held the view the Fed would rather risk excessive inflation than deflation, so it would be prepared to hold base rates for longer rather than choke off growth, even if inflation is starting to tick up. What are your views on the Fed raising base rates if inflation returns?”
Answer: Meaningful inflation is unlikely given where we are in the 120-year Kress cycle. The Kress mega cycle is scheduled to bottom in late 2014 and the implication is that until it does the inflation rate will be low. Meanwhile, symptoms of deflation should increase in certain areas of the economy as we head closer to that date.
Question: “I know there’s a debate of inflation vs. deflation (as suggested by the Kress cycles) at the moment. I think the only way inflation will come is if the liquidity in the system from printing money jumps to commodities (i.e. cost-push rather than demand-pull), which may well happen if the stock market continues to falter (basically a repeat of 2007-08). This may then kill the economy anyway. I therefore feel the Fed is somewhat backed into a corner and can't raise base rates (even if bond yields are suggesting they will, or that inflation is coming). What do you think?”
Answer: Let’s say for argument’s sake that stocks take a beating in 2014 as the final leg of the 120-year cycle bears down on the economy. Is it necessary that commodities benefit from the excessive liquidity provided by the Fed? Could we not see instead a repeat of 2008 when both stocks and commodities went down together? Financial crises usually hit both equities and hard assets since investors are forced to liquidate positions in order to raise cash. Even if the market avoids a crisis between now and 2014 (doubtful), keep in mind that much of the commodities weakness of recent months has been due to slackening demand from overseas as the effects of Kress cycle deflation are felt in Europe and Asia. This will eventually make its way to our shores.
As for the recent rally in bond yields, it should be kept in its proper perspective. It’s not necessarily the start of a new trend but instead is likely a recoil rally from an extremely oversold technical condition. It may also be the result of investors sensing an improvement in the economy’s near-term prospects as some have suggested. The long-term Kress cycle tells us to be prepared for continued low interest rates between now and late 2014, however. It’s highly unlikely that inflation will become a pressing concern until after 2014.