Contrary view: inflation and bond yields could decline

A vocal minority of economists contend that global market participants have exaggerated fears about accelerating inflation and higher interest rates.

Wall Street and other stock markets and sovereign and corporate bonds are jittery because of these worries.

Respected monetary economists, Lacy Hunt of the US treasury bond fund manager Hoisington Investment Advisors and Brendan Brown founder of Macro Hedge Advisors disagree with the economic consensus. They believe that inflation and long term bond yields are peaking.

They also warn that the US Federal Reserve Board (FED) and other central banks are similar to generals who are fighting the last war. They strongly believe that the US, European, Asian and other economies are beginning to slow down. If the Fed and other central banks agree with the economist consensus’ “inflationary psychosis” and raise rates, the business downturn could be worse than expected.

The chart shows that ten year Treasury bond yields are back to levels seen in 2019. For yields to rise further both economic growth and inflation need to accelerate. Both Hunt and Brown disagree with those who are bearish about long term US Treasury bonds. The ten year bond yield has risen to 1.77 per cent, but the 20 year bond yield has fallen to 2.12 per cent compared to the the 12 month first quarter 2021 peak of 2.43 per cent.

The Consensus: Economists who fret about inflation and want central banks to raise rates

Well respected economists such as Larry Summers of Harvard, President Bill Clinton’s Treasury Secretary and President Barack Obama economic advisor, contend that already high inflation will accelerate further and that interest rates should be hiked to counter it.

“There’s a witches brew of a tight labour market and loose monetary policy in the US,” Summers said.  

“I believe we are now driving above the speed limit. The central challenge is to achieve a gradual soft landing, and I believe that will require monetary policy substantially tighter than the Fed or the market now anticipate,” Summers recently opined at the American Economic Association.  

He added that “it was approaching absurdity to suggest inflation was caused by bottlenecks. Wages are rising at a 7.5 per cent annual rate.”

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Jeremy Siegel, professor of finance at the University of Pennsylvania’s Wharton School of Business, agreed that “a fresh surge in inflation” was making him nervous. He warned that accelerating pricing pressures could compel the Federal Reserve to raise interest rates at a faster clip than currently anticipated. Tech stocks could well slide but there could be a “rotation” into value shares. Speaking on CNBC Siegel added that it wouldn’t surprise him if the Fed raised interest rates six times in the coming year. This compares with the economist consensus of three to four times, starting in March.

Federal Reserve Chairman Jerome Powell said that high U.S. inflation could be prolonged into early 2023 because parts and material shortages might be getting worse. In their minutes on December members of the Fed board agreed that money should be tightened and hinted that interest rates should rise.

Disinflation and recession threat

Hunt of Hoisington believes that such policies are far too late in the day. US, European, Japan and China are already slowing down. Interest rate hikes would aggravate the downturn and as the year progresses inflation could turn into disinflation. If a recession occurs there could well be deflation. Hunt’s main concern is the extent of debt in the US and rest of the world.

“Historic trends and numerous scholarly studies have verified this deleterious impact of debt on economic growth,” Hunt says. “The US appears to be walking the same economic path of the Euro Area and Japan due to the growing indebtedness and shrinking real per capita growth.”

Debt, demographics and low velocity of money

Indeed the Institute of International Finance estimates that global debt amounted to US $295 trillion at the end of 2021 or a staggering 350 per cent of gross domestic product (GDP). Middle and lower income groups are weighed under by price rises that have already taken place and their commitments to pay interest and repay mortgages and other debt. A decline in the velocity of money— the rate of turnover between business and business and person to person— illustrates the debt strain on economies. US, European and Asian economies are slowing down once again. Other reasons for the probability of disinflation are the demographics of an aging population especially in Japan and China, Hunt says.

Cost inflation hurts the consumer and ultimately cuts demand. In those circumstances prices stabilise and begin to fall

Once the supply shortages that caused price jumps start to ease, competition and high inventories could force businesses to cut prices.

Brown of Macro Hedge Advisors maintains that the rate of inflation will not accelerate. Price increases during the two year pandemic have been an extreme shock to the economic system, he says. The bottom line is that inflation has already taken place and is a strain on the consumer and economy. Brown forecasts US inflation rate of around 7 per cent will subside to the 2 percent area later this year.

© copyright Neil Behrmann.(https://neilbehrmann.net)  A version of this article was first published in The Business Times Singapore . For other Asian and global articles try https://subscribe.sph.com.sg/publications-bt/

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