Inflation, which was supposed to be surging by now, is so low and still declining, that our thesis that QE will not end imminently and interest rates won’t pop up much from here is looking like it has legs. After the summer’s increase in rates, we weren’t looking very prescient. But now, articles are popping up in the Economist and the Wall Street Journal discussing the difficulties that low inflation present. The recent Economist article reminded us that Japan’s deflationary bout didn’t take hold until seven years after its real estate bust. And in fact, nearly every developed country is struggling with diminishing inflation. Only in Britain is inflation even close to the 2% preferred by central bankers, and there, it is 2.1%. In the US, we’re stuck somewhere between 0.7% and 1.2% depending on how you measure it. In Greece, prices are falling.
With a lot of production and employment slack in the world today (Spain’s unemployment rate is over 25%), forces propelling interest rates are simply missing. While short term interest rates need to be higher, we’re still not convinced that longer bonds will rise much in yield from here.