Tuesday, April 6, 2010

Is Deflation Off the Table?

From Bloomberg:

Federal Reserve Chairman Ben S. Bernanke and European Central Bank President Jean-Claude Trichet can’t afford to let the economic recovery distract them from the danger of falling into a deflationary morass akin to Japan’s.

Core consumer prices, which strip out volatile food and energy costs, rose a record-low 1.5 percent in February from a year earlier in the 30 countries that form the Organization for Economic Cooperation and Development. Goldman Sachs Group Inc. economists see core inflation falling further later this year to about 0.3 percent in the U.S. and 0.2 percent in the euro area.

The disinflationary trend is driven by the slack built up during the global economic slump. The 1.9 percent growth in OECD economies that the Paris-based organization forecasts for 2010 still will leave their total output for the year 4.1 percent below potential. With that much excess capacity, companies will remain under pressure to cut prices to keep customers and reduce costs to bolster profit.

Policy makers have “gotten their eye off the immediate ball, which is deflation risk,” said Joseph Gagnon, a former Fed official who is now a senior fellow at the Peterson Institute for International Economics in Washington. “It’s misguided for anybody to be talking about exiting” from stimulus during the next year.

Investors can profit from slowing inflation by selling Treasury Inflation-Protected Securities, Michael Vaknin, global fixed-income strategist for Goldman Sachs in London, said in a March 29 note to clients. The gap between yields on Treasuries and so-called TIPS due in two years, a measure of the outlook for consumer prices, stood at 1.56 percent on April 5, down from 2.92 percent on June 16, 2008.

This is not an issue I'm worried about, but maybe the Fed should be?