Although the sharp rise in real yields has been attributed to all the talk of the beginning of the end of US quantitative easing, the real cause has been the rapid disappearance of inflation in the US.
Falling inflation has been a global theme. Between January and April the pace of price increases in the US has fallen by around 0.5 percentage points; the same move down has been seen in Sweden, France, Italy and the UK. In Japan prices are still falling 0.7% per year even though the new premier has told the Bank of Japan to deliver 2% CPI.
The OECD measure of inflation in the G7 shows prices are rising by just 0.9% year on year, the lowest reading since November 2009. A year ago the figure was over 2%.
Outside the US the focus is understandably more on anaemic or absent economic growth. Posting performance the rest of us just dream of, the US saw its economy expand by 2.4% in annualised real terms in Q1. This appears to be an economy well on the way to normalisation.
Why then is inflation running at such low levels?
The reason is in part the sharp weakness in oil and clothing prices as well as falls in air fares, all driven by faltering global demand. With food and energy prices still falling, the downshift looks set to continue.
Central banks have all been following the script drafted by Ben Bernanke in 2002. Back then he was explaining how to avoid falling into a Japanese-style deflation trap; he has stayed on message. Nonetheless after several years of extreme monetary accommodation and the recovery of animal spirits in financial markets (at least until very recently) the deflationary pressures are as intense today as they have been at any time since the market seizure of 2008/09.
Against this backdrop all talk of reining back monetary policy in the US seems premature. In truth, and given the sustained loss of inflation in the US, one could easily ask why the US Federal Reserve is not redoubling its monetary efforts.
The monetary largesse still represents latent inflation – a huge well of buying power for a limited supply of goods and services in the future. The risk for investors remains, inflation expectations are once again buoyed by central bank actions and, in the wake of the recent market turmoil, they deem physical investments a better store of wealth than financial assets.
In this scenario of real asset price moves the recent rise in US TIPS’ yields represents a strong buying opportunity.
