Deflation Now, Inflation Later?

DALLAS — Asked for their forecasts, credit union economists and analysts told Credit Union Journal they see risk of deflation in the immediate term, inflation in the longer term.

"There are absolutely no signs of inflation picking up other than what you see in gold and oil," said Tom Manley, managing director at ALM First Financial Advisors. "Within the domestic economy (inflation) is not an issue. Wages are still down, rents are down and trending downward."

Though home values appear to have stabilized in many markets, many housing experts believe the adjustments to be seasonally-driven and creating the "mother of all head fakes" before prices fall another 10 to 15%. With savings soaring as consumers repair their personal balance sheets, low rates, tax credits and depressed prices have not been enough to boost demand high enough to force prices to follow.

"There has been no progress on the job market side. The best people are saying is that it's 'less bad,'" noted Dwight Johnston, VP-Economic and Market Research at WesCorp in San Dimas, Calif. "The work week has also fallen by a full hour since 2007 and there's a huge impact on income. Yes consumers might have to pay higher prices on certain goods like food and oil, but that just takes away from other (spending), which will drive our economy down. As far as the risk goes, I'm still more in the deflationary camp."

In New York, Pete Duffy, associate director with Sandler O'Neill, added, "We've had very low rates and a slope in the yield curve that is good for lenders for over a year and half."

But that has note been sufficient to help both consumers and financial institutions pull themselves out of the economic muck. With unemployment continuing to rise unabated, Duffy believes "there is still significant risk to the downside on asset valuations. Even those who think the recession is over are appropriately cautious that the recovery could be very flat and muted."

CUNA Mutual economist Dave Colby is hedged against both possibilities, arguing that neither deflation nor inflation is a major concern right now. He sees both rates and prices remaining within a "narrow and weak band" for the foreseeable future, though inflation concerns are "out on the horizon."

"If people don't see the dollar as a good return our suppliers move away from the U.S., then interest rates have to spike to get them back into the game," said Colby, who added that any currency crash will be somewhat muted by bottom-feeders that will keep the greenback from falling too far too fast. "If you're still in an extremely weak housing market or an extremely weak employment market your number-one concern over the next 12-18 months is credit," he continued. "If you're pulling a bunch of cheap deposits right now and going long with mortgages, you have a lot of interest rate risks."

Manley cited the Fed's monetary stimulus as a source for inflationary concern, but with lending still tight at many financial institutions, the velocity of that money is slowed considerably by the lack of compounding. Still, the sheer speed of the printing press will become a problem, just one that the country will have to deal with as the price for avoiding a depression.

With the unveiling of the Fed's new money market account, the central bank is telegraphing how it will suck liquidity out of the system. Manley urged CUs to pay attention to speeches and articles to decipher when the Fed is likely to start taking away the punch bowl, adding there is "no way they are going to do anything until they see something positive" with job creation.

Natural-person credit unions appear to be on the same wavelength. In Pensacola, Fla., David Tuyo, CFO with Pen Air FCU. sees "short-term credit risk and long term interest rate risk," and doesn't expect rate movement until at least October 2010, and then only a measured increase of 25 basis points per meeting from that point forward. David D'Annunzio, CFO at Heritage Trust FCU, expects rates to move "with the ebb and flow of economic data," but not start a sustained upward movement until late 2010. The Summerville, S.C.-based institution set its 2010 budget expectation for rates to remain the same range as they are today.