Over the past year we’ve had a wild ride in global yields. Today I want to take a look at the dramatic swing in yields and talk about what it means for the inflation picture, and the Fed’s stance on rates.
When oil prices made the final leg lower early last year, the Japanese central bank responded to the growing deflationary forces with a surprise cut of its benchmark interest rate into negative territory.
That began the global yield slide. By mid-year, more than $12 trillion worth of government bond yields across the world had a negative interest rate. Even Janet Yellen didn’t close the door to the possibility of adopting NIRP (negative interest rate policies).
So investors were paying the government for the privilege of loaning it their money. You only do that when you think interest rates will go even further negative, and/or you think paying to park your money is the safest option available.
And when you’re a central banker, you go negative to force people out of savings. But when people think the world is dangerous and prices will keep falling they tend to hold tight to their money from the fear a destabilized world.
But this whole dynamic was very quickly flipped on its head with the election of a new U.S. President, entering with what many deem to be inflationary policies. But as you can see in the chart below, the U.S. inflation rate had already been recovering and since November is now nudging closer to the Fed’s target of 2%.
Still, the expectations of much hotter U.S. inflation are probably over done. Why? Given the divergent monetary policies between the U.S. and the rest of the world, capital has continued to flow into the dollar (if not accelerated). That suppresses inflation. And that should keep the Fed in the sweet spot, with slow rate hikes.
Meanwhile, there’s more than enough room for inflation to run in other developed economies. You can see in Europe, inflation is now back above 1% for the first time in three years. That, too, is in large part because of its currency. In this case, a stronger dollar has meant a weaker euro. This–along with the U.K. and Japan–is where the real REflation trade is taking place. And it’s where it’s needed most, because it also means growth is coming with it, finally.
You can see, following Brexit, the chart looks similar in the U.K.–prices are coming back, again fueled by a sharp decline in the pound, which pumps up exports for the economy.
And, here’s Japan.
Japan’s deflation fight is the most noteworthy, following the administrations 2013 all-out assault to beat two decades of deflation. It hasn’t worked, but now, post-Trump, the stars may be aligning for a sharp recovery.
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