Tuesday, June 5, 2012
Contrary to a recent post on Zero Hedge which notes that 5-yr, 5-yr forward inflation expectations according to Bloomberg's calculations have turned negative for the first time ever, I have updated my chart using Bloomberg's calculations of this variable (USGG5Y5Y Index, for those interested). Rather than falling to unprecedented lows, forward inflation expectations have now risen to their highest level since last August. My own calculations of this rate confirm Bloomberg's numbers, so I'm at a loss as to how ZH got the story backwards.
In any event, as I noted in a previous post, it is very interesting that forward inflation expectations are rising at a time when 10-yr Treasury yields have plunged. Moreover, it's very interesting that this has happened while gold has fallen, commodities have fallen, and the dollar has risen. It suggests that the driving force behind collapsing Treasury yields (and this includes the sovereign debt of the UK, Germany, and Japan as well) is a budding global panic over the likelihood of a global recession, accompanied by fears that this will all end with currency debasement (particularly of the Greek variety) and thus higher inflation. Investors apparently have an insatiable appetite for risk-free, yield-bearing assets, because they fear that everything else will be negative, while at the same time reasoning that eventually (some years in the future) governments will resort to even more monetary stimulus that will reignite inflation. It's a curious state of affairs, to say the least.
Jon Hilsenrath's story that broke late today has contributed to the rising inflation fears today, since he reports that the Fed is once again considering another round of easing. I'm still having difficulty understanding how more Fed easing could solve the problem of insolvent PIIGS, and I note in this regard that 2-yr Eurozone swap spreads are not signaling any sudden or acute shortage of liquidity. Furthermore, it seems to me that another round of QE would only exacerbate what appears to be an acute shortage of high-quality sovereign debt (e.g., Treasury notes and bonds, plus the bonds of the UK, German, and Japanese governments, all of which are trading at extremely low yields).
What this suggests, of course, is that monetary policy easing is the wrong response to the problem at hand. We don't have a shortage of liquidity, we have a failure of policymakers to understand that in order to improve the health of the world economy, we need to shrink Big Government just about everywhere. More liquidity injections may be necessary to keep banks functioning and markets liquid, but for now they can't fix the underlying problem which is more spending than private sectors can afford to bear.
On the bright side, Scott Walker's solid victory in today's Wisconsin election is one more marker on the long road to smaller government, and that's good news.
Posted by Scott Grannis at 8:14 PM