LONDON May 3 For all the trillions of
dollars-worth in new money that central banks are printing,
financial markets seem to be signalling that fears of rampant
global inflation are unfounded.
Over the past month, investors have devoured virtually any
fixed income securities on offer, from the U.S. Treasury to tech
giant Apple, debt-laden euro sovereigns Italy or Slovenia and
even debut bonds from exotic African countries like Rwanda.
With 10-year yields on lending to United States or Germany
now little over 1 percent and the average coupon on high grade
global corporate bonds sold so far in 2013 just 4 percent, what
seems like ludicrously low 6-7 percent yields to compensate for
10-year Slovenian or Rwandan risk have been wowing the crowd.
Renaissance Capital chief economist Charles Robertson
described the sheer speed of this investor dash for fixed income
as "remarkable" and more evidence of a "global bond bubble".
Yet despite the underlying global growth slowdown and the
demand for bonds, investors have also continued to snaffle away
western blue-chip equities, where average dividend yields in the
United States and Europe are between 2 and 4 percent, and are
shunning income-less inflation hedges like oil and commodities.
Wall St's bellwether S&P500 index set record highs
again on Thursday and European equivalents clocked up
11 consecutive monthly gains in April. Oil, gold and copper
prices, conversely, are down between 10-15 percent this year,
with the drop in crude prices in turn acting as a powerful
depressant on imported inflation rates.
By way of some explanation, Barclays economist Michael Gavin
cited U.S. data going back to 1930s to say the mix of positive
but weak growth and soft inflation was traditionally a boon for
both equities and bonds.
"The rationale is that inflation and output tend to be weak
following recessions, leaving plenty of room for expansionary
monetary policy, which tends to boost equities," said Gavin.
"The current environment is no different."
So even as central banks in Washington, Tokyo and Frankfurt
continue to flood the world with newly-minted currency via bond
buying or cheap loans to their banks, long-held market anxiety
about the inflationary consequences appears to be ebbing.
Judged solely by the latest consumer price inflation numbers
around the world, it's not hard to see why.
Flashing a green light for this week's latest interest rate
cut from the European Central Bank, annual euro zone inflation
tumbled to just 1.2 percent last month - its lowest in more than
three years and far below the ECB target of close to but below 2
Earlier last month, much faster-growing China also reported
a drop of more than one percentage point in its annual inflation
rate in March to just 2.1 percent.
And with U.S. consumer price growth of little more than 1
percent also below the Federal Reserve's assumed target of 2
percent, the picture looks pretty consistent across the globe.
Critically, inflation expectations too are evaporating.
"Breakevens" measuring expected inflation in bond markets -
subtracting yields on inflation-protected bonds from nominal
yields of the same maturity - have tumbled sharply.
Five-year U.S. Treasury breakevens have dropped more than
half a percentage point in just six weeks to fall below 2
percent for the first time in eight months.
Little wonder, then, that an unemployment-focussed Fed this
week signalled no hurry to scale back its current spate of money
printing and bond buying and even said it may increase it.
So have inflation fears really disappeared? Well, not quite.
Asset manager Fidelity issued a report this week saying it
was all about long-term sequencing the cycle and investors
should just tilt portfolios gradually to the differing phases.
Right now may well be a sweet spot for both bonds and
equities, it said. But a long-term healing of credit markets and
rising global demand for food from swelling global populations
would eventually supercharge central bank money floods into an
inflationary pulse - even if it takes several quarters or even
years to materialise.
Given the lure of inflating away excessive Western debts
the authorities would tolerate, if not seek, rising prices. By
way of historical example, Fidelity showed that some 23 percent
of the drop in mountainous post-World War Two U.S. government
debt in the 30 years to 1974 can be accounted for by inflation.
British fund manager Legal & General Investment Management
dug deeper into structural forces behind inflation in a
presentation this week and reckoned a long-term stalling or even
retreat of trade globalisation could also unleash higher western
price growth in time.
Citing data showing a peak and plateau in global import
growth since the credit crisis, L&G IM said the disinflation
from cheap goods exported from China and the emerging world -
which it claimed cut UK inflation rates by about one percentage
point a year in the decade to 2007 - may also be at an end.
But what if the opposite is true? Enter the bears.
Societe Generale's persistently gloomy strategist Albert
Edwards says investors are missing the point and the risk is
outright deflation, or falling prices - with all the devastation
that holds for world's big debtors and equity investors alike.
For Edwards, central bank money printing - as with Japan in
the 1990s - is simply failing.
"Over the last 15 years, most investors have refused to
contemplate that events in the West are playing out in a similar
fashion to Japan in the 1990s," he said. "But the latest
inflation data out of both the United States and the euro zone
should ram home the fact that we are now only one short
recession away from Japanese-style outright deflation."