There Appears to be a Whiff of Deflation in the air if Treasury Yields are any Indication.
The data just may surprise you and solidify why I say that there is a whiff of deflation. Let’s start with a graph of the 10-year Treasury yield over the past year:
This is showing the classic pattern of lower highs and lower lows, suggesting the trend is for yields to continue to drift lower. Much of this drop has been a result of lower inflation expectations as the following chart shows:
What is causing such a significant drop in inflation expectations? The Wall Street Journal had a good article about fresh signs of a global slump and the challenges it may pose to the U.S. economy. Here are the main concerns cited in the article.
- Lower oil prices – This could actually be stimulative to the global economy, although the strong U.S. dollar mitigates this somewhat since oil is priced in dollars. It also creates significant pressure on high-cost oil producers like Venezuela and Iran.
- Consumer prices in Europe grew at the slowest pace in five years, raising fears that it could be tipping into deflation.
- Economic growth decelerated in India in the third quarter.
- Brazil’s economy has stagnated.
- Subdued consumer and business spending in the U.S. in October.
- 51% of Germany’s GDP is reliant upon exports
- 26% of China’s GDP is reliant upon exports
- European unemployment is at 11.5%
- Italy’s jobless rate is 13.5%, the highest since 1977
- Japan remains very challenged to overcome deflation as the sales tax increase really took some wind out of the sails of the economy
These point to a deficiency in demand. Essentially there’s too much saving leaking out of the system that is not flowing back into spendable income. So what are the answers? One of my favorite columnists, Martin Wolf of the Financial Times, just wrote a provocative article offering up some radical solutions. Here is what he suggested:
- Eliminate demand dependent upon unsustainable credit growth – I think this is a lot easier said than done.
- Hyper-aggressive monetary policy
- Large fiscal deficits
- Monetary financing of fiscal deficits
- This will take some of the direct money creation away from the banks and put it directly in the hands of the central banks
- Promote spending
- Tax unproductive savings
The purpose for citing these is not to convey an opinion about the efficacy of them, but to illustrate how concerned some people are about the lack of demand there is in the global economy such that labor markets remain sluggish, wage growth muted, and savings that doesn’t circulate back into the economy piling up.
Our bias, as previously mentioned in these blog posts, has been to be variable rate borrowers instead of fixed rate given our belief that interest rates would remain tame and the significant starting rate advantage. I see nothing on the horizon to change this strategy as that whiff of deflation comes rolling by.
Over to You
The classic pattern of lower highs and lower lows are suggesting signs of a global slump that may potentially pose a challenge to the U.S. economy. The current low-growth outlook is raising questions whether weak demand could dent the U.S. economy. Do you agree? Is there a whiff of deflation on the horizon? I’d like to hear your thoughts.