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Karen Maley

PIMCO warns 'deflationary scare' as Janet Yellen, Travis Kalanick feel investor rejection

Karen MaleyColumnist
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At first glance, US central bank boss Janet Yellen wouldn't seem to have much in common with Travis Kalanick, the Uber co-founder and chief executive who bowed to intense investor pressure and announced his resignation this week.

After all, the scrupulously polite 70-year-old Yellen is renowned for her caution and for the meticulous care she puts into preparing her arguments.

In contrast, the pugnacious 40-year-old Kalanick is seen as an extreme example of the brash and defiantly competitive Silicon Valley start-up culture, which is more than willing to thumb its nose at convention.

Support for Janet Yellen is beginning to crack.  Andrew Harrer

Indeed, Kalanick's abrupt departure from Uber – which has a valuation approaching $US70 billion ($93 billion) – came as a group of investors queried whether he had the ability to shake up Uber's corporate culture, following the stream of scandals that have rocked the company in the past few months.

But although Yellen is unlikely to have come across Kalanick in person, she will have spent a lot of time pondering whether his actions – and those of his peers – should affect her decision-making when it comes to raising US interest rates.

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There's no doubt that internet-based firms such as Uber, Amazon and Airbnb – big players in the so-called "sharing economy" – are exerting a huge deflationary force on the US economy. By using software to shake up long-entrenched industries, they're putting intense pressure on prices – and profit margins – across a swathe of industries, ranging from transportation to groceries to hospitality.

Downward pressure

Share prices of supermarket and grocery groups around the world hit the skids late last week after Amazon boss Jeff Bezos unveiled plans for the online giant to acquire Whole Foods Market in a deal valued at $US13.7 billion ($18 billion). That's because investors have little doubt that Amazon's move will put formidable fresh downward pressure on food and grocery prices.

But while investors are certainly taking note of the actions of Bezos and Kalanick and their ilk, Yellen has so far been sceptical of their longer-term impact. She continues to put far more weight on her economic models which tell her that improvement in the US labour market will inevitably translate into higher wages and rising inflation.

For example, at her press conference after the US Federal Open Market Committee meeting last week, Yellen dismissed the slide in inflation as a result of the price-cutting moves by the major US mobile phone carriers, painting it as as a transitory development.

Travis Kalanick's abrupt departure from Uber came as a group of investors queried whether he had the ability to shake up Uber's corporate culture.  Bloomberg

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But Yellen's stubbornness in clinging to her theoretical models means that, like Kalanick, she now faces a risk of revolt from once-adoring investors.

For almost a decade, Yellen enjoyed huge popularity among investors who cheered her stalwart defence of the Fed's ultra-easy monetary policies – which included near-zero interest rates and the Fed's massive bond-buying program. This massive monetary easing has helped propel global equity markets close to record highs.

'Hawkish mistake'

But support for Yellen is beginning to crack. Increasingly, investors are querying whether the Fed's plans for another rate hike this year and its desire to start winding back its $US4.5 trillion balance sheet make sense given that the US central bank has consistently failed to reach its 2 per cent inflation target. ​

In a research report released overnight, Joachim Fels, a global economic adviser to giant $US1.5 trillion US bond fund PIMCO, argues that there is a "substantial risk" that Yellen's plans to tighten monetary policy are a "hawkish mistake".

Joachim Fels says Yellen's tightening plants are a "hawkish mistake". Pimco

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In his note, Fels concedes there are some valid reasons for raising rates. Keeping rates very low for a long time squeezes bank net interest rate margins, which can cause them to cut back on lending. The Fed may also want to create more of an interest rate buffer, so that it has more room to cut rates when the next recession arrives. There's also a risk of asset price bubbles developing if the Fed keeps rates low for too long.

But, he argues, monetary tightening comes at a cost. "By hiking rates and starting balance-sheet runoff when inflation keeps undershooting, the Fed risks cementing inflation expectations firmly below target."

Although it may not matter whether inflation is running at 1.5 per cent or 1 per cent when the economy is continuing to grow, Fels says that "when the next downturn hits, there won't be much of an inflation safety margin against deflation."

He warns that with core US inflation running at 1.5 per cent even though the US economy is at close to full employment, "we are only one major adverse shock away from a serious deflationary scare".

Karen Maley writes on banking and finance, specialising in financial services, private equity and investment banking. Karen is based in Sydney. Connect with Karen on Twitter. Email Karen at karen.maley@afr.com

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