A policeman sees a drunk man searching for something under a streetlight and asks what the drunk has lost. He says he lost his keys and they both look under the streetlight together. After a few minutes the policeman asks if he is sure he lost them here, and the drunk replies, no, and that he lost them in the park. The policeman asks why he is searching here, and the drunk replies, “this is where the light is”. — The Streetlight Effect
The drunk in the above story is an idiot, of course. But no more so than modern economists who can’t find inflation because they’re looking only at the part of the economy covered by their government’s Consumer Price Index.
But gradually, grudgingly, a handful of mainstream economists do seem to be figuring out that the soaring value of stocks, bonds, real estate, fine art, collectibles and cryptocurrencies is a legitimate sign of a depreciating currency and future instability. Inflation, in other words. From yesterday’s Morningstar:
The de-synchronised nature of the recovery until now has also capped inflation in countries whose currencies have appreciated on cyclical outperformance. From here, however, common global uplift should help neutralise some of these inter-country effects, and allow domestic conditions to play out more powerfully.
Central banks have been puzzled by the lack of inflation, but have not stepped away from its management as the primary goal of policy. However, they’ve responded to the way QE’s impact has been much stronger in financial markets than the real economy by making financial conditions a larger part of their thinking, even if they’ve not formalised this in policy frameworks.
With inflation projected to lift and financial markets strong, we expect central banks to continue to gradually tighten.
Year to date, bond yields have drifted lower and curves are flatter, while credit spreads have continued to tighten.
Valuations of fixed-income assets have moved further into expensive territory with few exceptions. Term premium is close to historic lows and credit spreads at post-GFC tights.
Given this backdrop, our process continues to suggest defensive positioning remains appropriate until better value is restored. We see higher inflation and/or a faster pace of policy tightening as possible triggers.
This acknowledgement that soaring asset prices are kind-of-sort-of inflation is definitely progress, though the struggle it took to get there was obviously considerable. A single paragraph stating that asset bubbles constitute an especially destabilizing kind of inflation and therefore caution is advisable going forward would have made the point in a fraction of the time.
But it’s better than nothing. And who knows, maybe it’s the start of a trend.