Deflation is a bigger risk than inflation as Fed injects trillions into economy, BofA says

• The reflexive argument made by investors after the Fed injects trillions of dollars into the economy is to prepare for inflation, but Bank of America expects deflation, according to an analyst note published Friday morning.
• The bank argued that the net impact of the COVID-19 crisis and the policy response from Congress and the Fed was deflationary.
• "Core measures of inflation fell significantly in April and the weakness was broad-based across sectors," the bank noted.
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When the Fed and Congress inject trillions of dollars into the economy, most investors' gut reaction is to prepare for a period of inflation, as easy money sloshes around the economy.

But Bank of America takes the other side of that thinking, and instead expects deflation, analysts explained in a note published Friday morning.

The bank said the "reflexive argument" being made now was also made coming out of the 2008-2009 recession, as many investors "pointed to the massive 'money' creation by the Fed and the huge fiscal stimulus."

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But when looking at core CPI, prices have historically fallen both during and after recessions.

Based on the data so far, BofA is right.

In April, core CPI dropped 0.45%, marking the weakest data point since the index was created back in 1957.

That's on top of a 0.10% decline in March. A spike in prices for groceries was offset by a plunge in energy prices.

Another indicator of near-term deflation is a swift drop in producer prices, "with the headline measure down 1.5% over the two months and the core down 1.1%," BofA said.

Additionally, the April NFIB survey of small businesses showed the share of firms raising their prices was at its lowest level since 2009.

While prices are clearly falling, household inflation expectations are rising, based on the University of Michigan's recent survey of consumers' five- to 10-year inflation expectations.

Influencing the discrepancy is perception.

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"Items that are most in demand due to the shutdown - groceries, cleaning products, PPE etc. have risen in prices. Less visible [to consumers] are the numerous falling prices. For example, some people have been unable to pay their rent, pushing down the average paid price of housing services," BofA wrote.

Going forward, extreme price distortions due to the lockdown should subside, and the main driver of disflationary pressure will remain high levels of unemployment and unused productive capacity.

"The COVID crisis and the policy response to it are deflationary, and in the next couple of years outright deflation is a bigger risk than serious inflation," BofA concluded.

BofA isn't alone in expecting deflationary pressures to pick up in the future.

Billionaire investor Chamath Palihapitiya recently laid out his case for deflation and explained why he views bitcoin as the only investment vehicle to hedge against a future drop in consumer prices.