Back To The Future: Is Canada Heading For "Stagflation"?

Canadian inflation (core CPI) is running at an annualized rate of 2.3%, according to this mornings data release for June. That reading is up from last month's 2.2%.

Meanwhile many economists and perhaps even the Bank Of Canada see a chance that Canada's economy has entered into a recession (BOC cut the bank rate by 1/4% earlier this week).

5 year Government of Canada bond yields are below .75%, inflation is running at higher than 2%, that means that buyers of those safe 5 year bonds are giving up at least 1.25% each year after inflation (a negative "real" return). How long will bond investors be prepared to put up with negative returns? 

While the Bank Of Canada has cut the bank rate by 1/2% (and there is speculation that they may cut again by another 1/4 %) thus far this year, Canadian banks have only cut their prime rates by 1/4%. 

Clearly there is a disconnect from what has been the usual economic progression. We are indeed in uncharted territory, post oil price shock developments.

Meanwhile, inflation data from the Euro area and the US this week show a slight uptick in inflation in those economies as well.

Low interest rates and low "real" (after inflation) returns are forcing investors into riskier assets (like equities), driving prices for equities higher.

Meanwhile corporations are buying back their own shares at levels not seen since 2007 (according to Bloomberg) further pushing equity prices up.

This is in fact distorting earnings per share data. While earnings are stagnant or declining, fewer shares make the EPS data look better. But even EPS data is well above it's historical averages.

Folks, there is a whole set of situations developing that just do not make reasonable sense from my perspective at the moment and that warrants caution.