Markets Insight
January 6, 2015 8:28 am
Deflation is a rising threat for markets
John Plender
The world is prey to the growing problem of deficient demand
Why did so many market pundits fail to foresee the decline in yields across the developed world in 2014?
The short answer is that they were obsessed with the potential impact of the US Federal Reserve’s retreat from unconventional measures while neglecting the importance of global imbalances. In effect, the world has been prey to a growing problem of deficient demand, leading to disinflation, while the US has been growing too sedately to spark the inflationary pressures that would have called for much tighter monetary policy. There is a risk that forecasters will make the same mistake in 2015.
Consider the state of the world’s excess savers, starting with Japan. There Abenomics is having difficulty addressing deflation and raising economic growth. Weak demand resulting from adverse demographics and the recent consumption tax increase means the country is dependent on yet more bond buying and further yen devaluation to generate the cost-push pressure that would enable the Bank of Japan to meet its 2 per cent inflation target.
China, meantime, is going through an awkward transition whereby its astonishingly high rate of investment is beginning to decline. Domestic demand growth has flagged. This has contributed to the fall in global commodity and energy prices. At the same time China faces a more competitive export environment as others, spurred by Japan, engage in competitive devaluations.
As for the eurozone, it is being driven towards deflation by a moralistic drive for austerity which does nothing to arrest rising debt as a percentage of gross domestic product because the harder hit economies have shrunk. Disagreement on the governing council of the European Central Bank ensures a crabwise progression towards full scale government bond buying without which its inflation target will not be met.
The combination of dollar strength and declining Treasury yields seems likely to persist.
Elsewhere in the developed world yields are set to rise, chiefly where default risk enters the picture, as in Greece on the basis of recent political instability.
Elsewhere in the developed world yields are set to rise, chiefly where default risk enters the picture, as in Greece on the basis of recent political instability.
Given the structural flaws in the monetary union, the ECB’s dilatory approach to quantitative easing and German-led fiscal conservatism, that may not last. More generally, against the background of a rise in non-financial debt in advanced economies from 212 per cent of GDP in 1999 to 279 per cent in 2014, of which more than half has taken place since the global financial crisis, occasional neurotic spasms in the markets are inevitable.
Emerging markets will have a much tougher time in this deflationary world. They may again become an important locus of global financial instability, and not just in Russia. US dollar denominated non-financial debt outside the US now stands at more than $9tn, according to the Bank for International Settlements, compared with $6tn at the start of 2010. The biggest increase has been in corporate bonds issued by emerging market companies tapping investors desperate for yield. The currency mismatch means a strengthening dollar tightens financial conditions as attempts to pay down dollar debt forces the dollar higher, causing a vicious circle.
The writer is an FT columnist
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