If you listen to some market observers, the record low yields in the Treasury bond market are warning us that the American economy is on the verge of falling into the same deflationary abyss of the euro zone and Japan. Like the Chicken Little story, if bond yields are falling, the sky must be falling, too.
With the yield on the 30-year T-bond hitting its lowest level ever last week, even lower than during the global financial crisis, they’re worried that if the Federal Reserve raises interest rates soon, we’ll shortly be back to the bad old days of 2008 and, even worse, 1929.
No less a figure than Paul Krugman, the New York Times’ economics commentator, wrote that the Swiss Central Bank’s move last week to decouple the franc from the free-falling euro is a portent of what could happen to us if we let our deflationary guard down.
“Switzerland’s monetary travails illustrate in miniature just how hard it is to fight the deflationary vortex now dragging down much of the world economy,” Krugman wrote. The Swiss move, he said, demonstrates “just how hard it is to fight the deflationary forces that are now afflicting much of the world — not just Europe and Japan, but quite possibly China too.”
Without any evidence that we’re even close to deflation here – or in China, either, for that matter – Krugman concludes that “while America has had a pretty good run the past few quarters, it would be foolish to assume that we’re immune.”
As a result, he says, the Fed should be “very cautious” about raising interest rates. Why? Because “market indicators of expected inflation are plunging, suggesting that investors see deflationary risk even if the Fed doesn’t.”
“I share that market concern,” he concludes. “If the U.S. recovery weakens, either through contagion from troubles abroad or because our own fundamentals aren’t as strong as we think, tightening monetary policy could all too easily prove to be an act of utter folly.”
Likewise, in a column last week, under the headline “The Bond Market Is Warning of Huge Trouble Ahead,” The Fiscal Times warned that that the government bond market is “pricing in a debt-deflation cataclysm” if not a “debt-deflation depression.”
Another Fiscal Times column warns that the “doldrums” that the other major economies are stuck in “will hamper what could otherwise be a very strong U.S. economic recovery… Without strong trading partners, it’s hard to see a way for it to achieve sustained high-level growth.”
This sounds more to me like a bad case of hypochondria. These commentators seem to believe that the old saw about the rest of the world catching cold when the U.S. sneezes works in reverse.
Well, it doesn’t.
The euro zone and Japan are not capable of dragging our economy down to their level. It works the other way around. We are usually capable of pulling them out of their torpor, although obviously they’re in such bad shape now – largely due to their own failed policies – that this has proven to be even beyond our ability to help.
If anything, as I noted in an earlier column, low bond yields in the U.S. are the result of reality returning to the bond market, much as water seeks its own level. Record low bond yields in Europe and Japan have pulled down rates in the U.S., which had been grossly underpriced relative to those countries.
Investors are now stampeding into Treasuries as they always have in times of trouble, even if the problem is somewhere else, not here.
While the European Central Bank appears poised to announce a new sovereign bond-buying program – possibly as early as this Thursday’s meeting – to boost the feeble euro zone economy out of its “debt-deflation depression,” the U.S. is moving in the opposite direction.
On Tuesday the International Monetary Fund revised downward its forecast for world economic growth to 3.5% this year, down from the 3.8% pace its projected back in October, the steepest cut in its global-growth outlook in three years. It also cut its estimate for growth next year to 3.7% from 4% earlier.
But the U.S. was the exception. The IMF upgraded its 2015 forecast to 3.6%, up from 3.1%.
A week earlier, the World Bank did much the same thing. It cut its global growth estimate for this year to 3% from 3.4% and for next year to 3.3% from 3.5%. Meanwhile, it raised its 2015 projection for the U.S. to 3.2% from 3%.
Last week a committee of 15 chief economists at the largest banks in North America predicted that the U.S. economy will grow nearly 3% this year, up from 2.5% last year, more confirmation of a continuing growing economy.
Not only that, but the bank economists see falling energy prices as a “net positive” for the economy, in contrast to another piece of nonsense we keep hearing lately, namely that plunging oil prices are now all of a sudden a bad thing for the economy at large.
And as I noted in my most recent column, disinflation or deflation or whatever you want to call it just isn’t in the cards in the U.S., no matter what some Nobel laureates think. The median change in consumer prices last year was 2.2% after subtracting out oil prices, suggesting that deflation concerns are way overblown.
As investors, we can bemoan the fact that interest rates are so low. But we can’t blame deflation or a weak economy for it.
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INO.com Contributor - Fed & Interest Rates
Disclosure: This article is the opinion of the contributor themselves. The above is a matter of opinion provided for general information purposes only and is not intended as investment advice. This contributor is not receiving compensation (other than from INO.com) for their opinion.