For most pundits and policymakers the deflation vs inflation debate is over – rising inflation is the bigger threat to the global economy.
But not for Société Générale’s ‘permabear’, Albert Edwards. He has warned investors that the end of the US government’s bond buying programme in June (quantitative easing part II, or QE2) will cause “a deflationary bust” that will send shares plunging. So he actually advocates buying Treasury bills, as deflation – and risk aversion following the equity crash – will push up their price.
The Soc Gen strategist has form. His 1996 ‘Ice Age’ thesis predicted that equities would enter a long-term bear market and be outperformed by government bonds. At current market levels, that call was a good one.
Edwards admits that his bullish stance on bonds is contrarian. After all, the end of QE2 should mean that fewer people are buying bonds, which would cause the price to fall. Demand should also come under pressure from the “ruination of the public sector balance sheet”.
When governments become more indebted, and therefore more risky, investors normally demand higher yields. And rising yields means falling prices. Moreover indebted governments are more likely to print more money and push up inflation.
Yet Edwards is convinced that before any of this happens we will see a deflationary bust. His logic is that “the printing presses being turned off will hit risk assets hard”. That will send stock markets falling. For example he think the S&P 500 – America’s main index – will fall by around 70%.
Yet unlike other bearish commentators Edwards believe this will actually benefit bonds. Investors faced with losses in equities will look for something safer. And that “should boost Treasuries”.