Harbour Monthly Commentary: The Threat of Inflation or Deflation

• Global bond yields have fallen back to recent lows, as a soft patch in global economic activity has been followed by a realisation that global inflation has also been falling below target.
• Indeed, the IMF have highlighted that the real puzzle is not why inflation is so low; but rather why we haven’t seen deflation.
• With inflation expectations so firmly anchored, the Federal Reserve, Bank of England, and Bank of Japan are all erring on the side of providing too much stimulus, rather than providing too little.
• While we expect yields to rise from their lows in the medium-term, in our view this requires stronger economic data is required as a catalyst.
• Global growth expectations for 2013 are still broadly the same as the 2.0-2.5% growth delivered in 2012, which seems unlikely to unhinge inflation expectations for now.

Global Bond Yields Back at Lows

Over January and February, the US 10 year bond yield rose from 1.70% to as high as 2.10% as the market’s worst fears about the US fiscal cliff did not eventuate, and the US economy showed continued signs of economic recovery.  However, since mid March, the US 10 year bond yield has fallen back to its lows for the year, falling as low at 1.65%.  

At first, this move was triggered largely by signs that the US economy had hit a softer patch with business confidence abating and employment growth slowing.  At the end of 2012 the US Federal Reserve had introduced the Evans Rule, which made it clear that it intended to keep monetary policy loose as long as unemployment remained above 6.5%.   In other words, it had given job growth prominence over inflation in its dual mandate.  And the market had focused on the weakness in employment and business confidence over March as a driver of lower yields.