Forecasters are wrong: we are not really getting inflation in the US

Outlook:

We should probably be grateful that the improvement in the outlook is not trig-gering a taper tantrum, but the persistence of low yields is still a puzzle. The implication is that inflation expectations are still very low, or that analysts and traders can't see central banks giving up QE at any pace that would be worrisome, or that demographic changes point to a permanent-ly higher preference for safe assets. This last is the FT's Authers' idea and we always heed what Au-thers has to say.

Note also that the IMF and OECD have been issuing warnings about slower growth for many months now, but at least some of the data shows otherwise. Granted, South Korea just reported GDP up only 2.7% in Q3, from 3.3% in Q2, dampening the Kospi, among other effects. We also have slower growth in crisis places like Turkey, but in the developed world, Germany, for one, claims rising growth. Last week we had an upbeat ZEW report, then a good flash PMI yesterday and today, a really good IFO. The only thing risky in Europe today, according to ZEW and IFO, is Brexit. ZEW president Wambach is more worried than IFO. Wambach said "political risks within and outside of the European Union are weighing on an optimistic economic outlook for Germany." And banking remains an issue. But IFO economist Wohlrabe said "The Brexit vote has been digested" and the failure of the Canada-EU deal doesn't do any harm to the German economy.

We don't buy this story for a minute. German newspaper Rheinische Post reports today a study by the IW Cologne Institute that shows Brexit is going to shave 25 bp off German growth over the next year. German exports will fall as much as 9% in 2017. German exports to the UK were €89 billion last year, so the UK is Germany's third most important export market. How can this not have a chilling effect? The ZEW and IFO chiefs are talking about sentiment, not data. Initially, Germans overreacted nega-tively to Brexit. Now the pendulum has swung too far to the "We're all right, Jack" direction. It may take a while for the negative consequences to sink in. On Thursday we get UK GDP, forecast to be okay. The WSJ has a forecast of 0.4% in Q3 after 0.6% in Q2, a shrugging off of the Brexit effect. Just wait. It's coming.

Back in the US, Chicago Fed Pres Evans said he sees three moves between now and end-2017. Evenas is not a voting member this time but all the same, the market's refusal to react strongly is a big shock-ing. Three hikes? Right now most analysts see a single hike next year, not two, and that's assuming we get the hike in December. Evans is assuming GDP at 2%-2.5% in the second half of the year and the same numbers for 2017. This is not consistent with other forecasts and may account for his prediction lacking weight. Here's the kicker: during the Q&A, Evans said "shocking demand for safe assets" is holding down rates.

St. Louis Fed Pres Bullard, who is a voter this time, said the hike in Dec is the most likely outcome, barring a shock. A Stone & McCarthy analyst, echoing Evans, said "a big risk for the bond market would be that the pace of the Fed's rate increases in 2017 may be faster than many investors antici-pate." The WSJ notes "The 10-year yield has been rising from 1.605% traded at the end of September, but it remains lower compared with 2.273% traded at the end of 2015. Some traders warn that the yield could rise to 2%, a level it last traded at in March, by the end of this year. Others say buying interest would grow if the yield rises closer to 2%.Many investors don't expect a sharp rise in bond yields un-less the global economy or inflation accelerate."

We say all the forecasters are wrong. We are not really getting inflation in the US. Growth is decelerat-ing, not accelerating. Germany may feel cheery about its prospects, but it's not getting inflation, either, and growth is at risk from Brexit. Only in the UK are inflation expectations well-founded, and while growth may look okay when GDP is released Thursday, it's still a backward-looking indicator that doesn't account for changes still in the works. Japan is trying to sell the same tired old story of moder-ate recovery and is out of gas. China is devaluing whether it admits it or not, and a deliberate policy of devaluation is an act of desperation, especially because it risks capital flight.

Therefore, assuming the Fed does suggest the Dec rate hike at the next meeting, we still can't expect US yields to rise in lock-step. Too many doubts remain, not only about the US economy but also about what awful thing may emerge elsewhere. As for Evan's prediction of a total of three hikes, clearly no-body believes him. Talk of a new dollar rally depends on altogether too much acceptance of fictional outcomes. The emperor is only partly clothed. We can easily create a scenario in which the dollar fails to gain much traction and even goes backwards for a while until the dust settles. As usual, we are data-dependent. One of two lousy bits of data can derail the dollar. Be wary.