Fear leads inflation expectations lower

By Cees Bruggemans, Chief Economist of FNB.

It looks like there were ultimately two moments of truth in recent times. The moment of panic crisis (back in late 2008), and again very recently once past the initial recovery bounce when faced by the sustained recovery question.

It turns out that not every disturbed soul switched back on the juices yet once past the crisis moment.

Indeed, deep questions lingered.

About government fiscal sustainability (them not being able to borrow excessively indefinitely).

About central bank accommodation (would it ultimately prove inflationary?).

About housing markets (some still imploding?).

About banks (still fragile). About households (still deleveraging). About businesses (still in shock and preferring to lay off labour and emphasize productivity enhancement and earning restoration). About equity markets (how much downside?).

Leaving only cash and bond markets (how much upside?).

Financial markets act on perceptions. And the times apparently remain suspicious and anxious.

With growth slowing nearly everywhere (except Germany, for now) once past the inventory correction and fiscal boosts, and with all those questions remaining as listed above, there remained many who preferred safe haven cash or near cash (US, UK and German government bonds).

Real bond yields (and inflation expectations) collapsed during the 4Q2008 crisis, rebounded gratefully during 2009 to pre-crisis levels, but since early 2010 a renewed relapse in real bond yields and inflation expectations appears to be underway, if more slow motion than in 2008.

It needs to be seriously asked: is this for real?

The renewed subsidence of leading government bond yields, the steady downward drift in rich world inflation and the renewed drop-off in such real bond yields are all factual and very real.

Does it also signify a drop in inflation expectations, from preferred targeted levels to dangerously low cliffs separating us from deflation?

There is at least the hint that increasing numbers people fear this tendency. And once psychologically committed to a thought, is it but a small step to act on the presumption and making it come true in a self-fulfilling reinforcement.

But will Western growth genuinely double-dip, will China really shock our senses shortly, will inflation in many countries really cease and topple over into deflation, will asset markets other than fixed income really suffer decline as a consequence?

Only time will show up the real answers to these many propositions. Meanwhile global investors are acting and they are not piling into commodities (except precious metals, a bad sign), equities or real estate. Instead, already very dear bonds (2% nominal return for ten years, anyone?) and nil-return cash are the darling investment vehicles of choice.

To put it mildly, these are very insistent and disturbing tendencies, as much fearing the apparent drift of things as the policy solutions on offer.

For not everyone is apparently equally happy with what central banks may still try next. As UBS senior advisor George Magnus put it last Thursday in the FT, “print more money and be damned, don’t print more and invite chaos”.

And that is from someone apparently favouring more printing. It shows the uncharted territory we seem to have drifted into.

“You want me to do what” screamed the body as the mind of the determined bungee-jumper proposed to overrule all opposition and JUMP