David R. Kotok
August 26, 2014
A worldwide deflation fear is expanding and may actually be rampant. BCA Daily Insights (August 25, 2014) notes that, “out of 32 OEC countries, more than two-thirds have domestic inflation rates that fall short of 1%.” BCA analysts go on to argue that the worldwide inflation rate may converge to zero over the next couple of years.
Debt markets currently reflect this fear. Here are examples of yields on the benchmark 10-year interest rate for sovereign debt. This is not about credit risk. This is about the risk that the global price-level change will approach or reach zero.
1. United States 10-Year Treasury Yield, 2.4%
2. Germany 10-Yield Bund Yield, under 1%
3. Japanese 10-Year JGB Yield, under 0.5%
4. France 10-Year Government Bond Yield, 1.3%
5. Canada 10-Year Government Bond Yield, 2%
6. United Kingdom 10-Year Government Bond Yield, 2.5%
7. Mexico 10-Year Government Bond Yield, 3.2%
8. Italy 10-Year Government Bond Yield, 2.4%
These are unexpected and remarkably low yields. They reflect the results of central bank policies and the results of growing fear of disinflation or even deflation.
Is it any wonder that central bank actions which expand quantitative easing produce little or nothing beyond growing balances of excess reserves as those created monies recycle back into the central banks? Is it any wonder that an alternative form of recycling monies in the US, the reverse repo, is currently functioning at an administered interest rate of 5 basis points (0.05 of 1%). The answer is No!
Worldwide deflation risk is serious business, and it is rising in the eyes of market agents. It means that central bank policies are neutralized. The central banks of the world have tripled the amount of excess reserves since the financial crisis commenced. If they were to quadruple the amount of reserves in the next year, doing so would not make much difference. Does it make any difference if the Federal Reserve holds an extra half trillion dollars of Treasury securities that are reflected in a rising balance of a reverse repo or in additional excess reserves? The answer essentially is no.
For the last six years, central banks worldwide have collectively offset the failure of their governments’ fiscal policies. That is about all they could possibly do. They have enabled nearly all creditworthy corporate and institutional borrowers to successfully undertake refinance at very low interest rates. That is about all they could possibly do. They have enabled creditworthy individuals and households to refinance household debt in order to realign their debt service payments. That is about all they could possibly do.
The burden of turning global economies around now falls on governments and their fiscal policies – policies that encourage growth, policies that diminish taxation, policies that expand trade, policies that address rising geopolitical risks that interfere with the expansion of trading.
Government officials’ criticisms of companies that want to seek better tax policies are specious and harmful. US Treasury threats to investigate “unpatriotic” transactions and other government interferences lead to contraction of trade, reduction of economic activity, and suppression of growth.
Unfortunately, governing executive branches, including the Obama administration in the US, still do not get it. The legislative branches in the mature economies and governments of the world continue to appear to be broken. The culprits are not the central banks. They have done all that they can.
We remain in the camp that suggests the short-term interest rate will be near zero for a long time in the world and for, at least, another year in the US. After that we expect that the short-term rate will rise very slowly here. It may not rise at all in some places in the world for the rest of the decade. Our US Exchange-Traded Fund accounts are fully invested.
David R. Kotok, Chairman and Chief Investment Officer, Cumberland Advisors