ORLANDO, Fla., March 29 (Reuters) – Remember ‘japonification’?
After the financial crash of 2008, a consensus emerged that the United States and Europe would slide into the kind of decades-long economic malaise that Japan experienced after its 1990s real estate crash – where the effects of a rapidly aging population have seen waves of excess savings, slow growth and lingering deflationary pressures.
Called “Japanification,” the diagnosis involved chronically low or negative interest rates and bond yields, with repeated bouts of “quantitative easing” bond buying and mounting piles of debt.
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When COVID-19 hit, many doubled down on this view.
And yet, inflation in the United States and Europe has reached its highest level in four decades.
Initially dismissed as transitory due to the bottlenecks and base effects of post-pandemic reopening, the price increases are proving more durable and widespread than central banks had hoped and many are already raising interest rates. ‘interest.
An energy price shock since Russia’s invasion of Ukraine is compounding the problem. And US Treasuries had their worst quarter in at least 25 years.
So is the thesis of “japanization” dead?
Steve Major, head of global fixed income research at HSBC, says it’s very much alive and offers three big reasons: recent Fed projections, current market prices and long-term structural drivers that existed before 2008.
Federal Reserve policymakers this month raised their median projection of where they see rates peaking at 2.8% next year from 2.1% in 2024, according to their December forecast.
This is well into “tight” territory – defined as rates above the Fed’s long-term neutral rate assumption – and raises the risk of a recession that will likely see bond rates and yields come back down quickly.
Several measures of yield and rate curves – nominal, real and forward – support this view.
Importantly, Fed policymakers also lowered their long-term neutral rate forecast to 2.4% from 2.5% since 2019. This is not a rounding error, but the result of three decision makers who downgraded their long-term outlook.
The Fed is essentially indicating that the long-term trend in the neutral interest rate is still down because the economy is not strong enough to sustain higher rates.
Ultimately, the deflationary pull of huge and rising debt levels, aging populations, high degrees of wealth inequality, and rapid technological advancements is strong.
“These trends are very powerful and are things that the central bank has no control over. Can the central bank control the age of people?” Major says, adding, “The lower for more long “is intact. the moment sustains it.”
The pandemic has cast doubt on the long-held view that aging and associated labor shortages over time are as deflationary as Japan’s experience suggests.
The most powerful of these arguments – laid out by economists Charles Goodhart and Manoj Pradhan just before the pandemic – is that labor shortages will ultimately increase the bargaining power of labor and wages and contribute to raise prices more generally.
But demographics are a double whammy for long-term interest rates. Aging populations and a shrinking workforce reduce potential growth rates over time, while workers nearing retirement generally put their life savings into safer bonds.
Surges in inflation and rising bond yields are possible, as we are currently seeing, but they are less likely to last.
Curiously, one of the Fed’s most hawkish rate setters revealed that the Fed still agrees with the “lower for longer” outlook.
St. Louis Fed Chairman James Bullard opposed the Fed’s 25 basis point rate hike to a range of 0.25% to 0.50% on March 16 and voted to an increase of 50 basis points. He has since called for a rate hike beyond 3%.
But he also sees the long-term equilibrium policy rate at 2%. Assuming the Fed brings inflation back to its 2% target, this implies a real policy rate, known as the “R-star,” of zero.
R-star estimates vary and the Fed’s median estimate is now 0.4%, so zero wouldn’t be a complete surprise. The New York Fed stopped updating its estimates in 2020 due to the pandemic, but the long-term downward trend is clear.
Societe Generale’s Albert Edwards has been a long-term bond bull for all of these structural reasons, aptly calling falling yields and interest rates his ice-age view of the global economy and markets.
He thinks a thaw will eventually come and inflationary pressures from soaring commodity and energy prices, fiscal largesse and expanding deficits will overwhelm and crash the bond market. .
But despite the scramble to revalue bonds amid hawkish central bank policy in recent months, this earthquake is still not the biggest one.
“It’s not the end of the short-term bond bull market. This commodity boom will ultimately be deflationary and kill global demand,” Edwards said, adding, “The Fed is going to tighten until it gets get the economy back into recession, and it won’t take very long.”
Edwards believes the 10-year Treasury yield may revisit its August 2020 all-time low around 0.5%, a level historically associated with Japanese yields.
(Views expressed here are those of the author, columnist for Reuters.)
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By Jamie McGeever; Editing by Andrea Ricci
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The opinions expressed are those of the author. They do not reflect the views of Reuters News, which is committed to integrity, independence and non-partisanship by principles of trust.