Welcome to Market Predict

Global bond market forecasts continual low inflation

By Neil Behrmann

April, 05:- Those who believe that inflation is about to take off had better examine trends in the US$38 trillion global bond market.

Long term bond prices, which are intricately linked to inflation expectations, have shrugged off pessimistic forecasts of economists. In the past year, ten year US Treasury bond yields have fluctuated between 4 to 4.5 per cent. Meanwhile recession in Germany has caused ten year bond yields there to tumble to 3.7 per cent. UK government bond yields are 4.7 per cent and Japanese yields are only 1.4 per cent. These low yields, which are close to levels seen in the stable economic period of the 1950's, are saying that at worst any inflation acceleration will be temporary and mild. Indeed inflation could decline once again in 2006.

In contrast to bond market investors, many economic and financial forecasters have been predicting that inflation will accelerate. Economic expansion, relatively low interest rates, the slide of the US dollar and surge in energy prices and other commodities were bound to cause an inflation problem, especially in the US. Long term US and global bond prices would slump and their yields would surge, economists predicted.

So far, however, the main long term bond investors, notably pension funds and insurance companies, have outplayed most economists. They have taken the view that real, inflation adjusted yields, will remain positive in the long term. Indeed even though long term bond yields are historically low, they are still exceeding inflation. In the 12 months ended December 2004, consumer price increases of the 30 member nations of the Organisation For Economic Cooperation And Development (OECD) rose by only 2.8 per cent. This stability is impressive considering that consumer energy prices surged by 11 per cent last year and were on a rising trend in 2003. Last year US consumer prices rose by 3.3 per cent, the UK by 3.5 per cent, Germany and France by 2.1 per cent and Italy by 1.9 per cent, according to the OECD. Japan's consumer prices rose by 0.2 percent, while Singapore's consumer prices were up by only 1.5 per cent and China and Korea by 2.4 per cent and 3.1 per cent respectively.

Using other measures such as the Federal Reserve Board's Personal Consumption Expenditure (PCE) price index, year on year core inflation is around 1.5 per cent in the US. This implies that the real inflation adjusted ten year treasury yield is 2.5 per cent. Other inflation measures, notably the OECD's gross domestic product deflator state that Japan continues to be mired in deflation, so Japanese real long bond yields are 1.5 to 2 per cent.

Granted, there has been mild inflation acceleration in the US and countries
such as China. Nevertheless the bond market has a good chance to win the
2005 forecasting race again:

Central banks are still in an inflationary mindset after OECD nations' average inflation soared at an annual rate of more than 10 per cent in the seventies and remained at high, albeit declining trends in the eighties. Thus the Fed, Bank of England and central banks in Australia and New Zealand have tightened the monetary noose and have raised short term interest rates to keep inflation in tow. The European Central Bank inflexible hawkish monetary policy has kept short term interest rates and the euro at levels that have driven Germany and Italy into recession.
Appreciation of the euro and other currencies against the greenback slashed import prices.
Speculative money pouring into Asian currencies forced monetary authorities
to allow mild revaluations that also curbed prices of imports.
Globalisation and World Trade agreements reinforce anti inflationary trends as they improve competition. Manufactured goods have been getting cheaper, both in absolute terms and relative to services. Since 1996, the average price of clothes in Britain has fallen 36 per cent as textile manufacture has shifted to Asia. Household appliances, computers, printers, toys and cars are much cheaper than the mid nineties.
Outsourcing is becoming increasingly prevalent. This places pressure on labour markets in the US and Europe. Workers, concerned about their jobs raise their productivity and find it difficult to ask for extensive wage increases.
Demographics, notably the growing numbers of older people who perceive that pensions are inadequate, curb consumption.
The global economy has been growing at a solid pace, but capacity utilisation in the US is only 79 per cent, compared to 74 per cent in 2001 and around 85 per cent in the eighties and early nineties.
Oil and other commodity prices have been both inflationary and disinflationary. The rise in prices in 2004 raised the cost of production. But down the supply chain, many businesses have to bear the brunt of the costs. They are forced to slash other overheads to maintain profitability. If economies, including China, slow down in demand will decline. In the meantime producers are in the process of raising production. These trends should ultimately bring about price declines.

Dec 98

May 99

May 00

June 01

Nov 01

May 02

Jul 02

Sep 02

June 03

Apr 05

4.25

5.64

6.38

5.35

4.34

5.20

4.81

3.65

3.04

4.27

Germany

3.70

4.15

5.28

5.07

4.34

5.20

5.00

4.26

3.40

3.45

4.30

4.94

5.30

5.17

4.51

5.28

5.10

4.36

3.48

4.58

Japan

0.84

1.17

1.66

1.22

1.31

1.40

1.32

1.28

0.43

1.26

Canada

4.68

5.75

6.70

5.75

5.02

5.69

5.54

4.80

3.98

4.16

Australia

4.90

6.06

6.47

6.04

5.15

6.28

6.07

5.33

4.60

5.36

NZealand

5.40

6.36

6.63

6.75

6.13

6.90

6.66

5.96

5.04

5.98

Top

Content on the site is copyright of Marketpredict.com and its writers. Reproduction of this publication's copyright material is not permitted in web, electronic, printed or any other form without the written consent of the publisher. See Dangers of Flouting International Copyright Law For syndication rights please email syndication@marketpredict.com. This site is for information purposes only. The publication neither recommends nor advises on the investment and trade in currencies, bonds, stocks, commodities, futures, options, other derivatives, funds or any other financial or investment product or instrument. All information has been obtained from sources believed to be reliable, but accuracy cannot be guaranteed. Readers are solely responsible for the use of this information. They should not rely on it and should regard it as only one of their sources. They should seek advice elsewhere. The publisher of Marketpredict.com, panellists, other forecasters and contributors disclaim liability for any loss, damage, injury or expense that might arise from the use of the information and services contained herein. For further details on Marketpredict's code of conduct, disclaimers and dangers of flouting international copyright law, please examine Who We Are.