Japan’s Nikkei has entered bear territory. Other Asian markets have suffered sell-offs, too. The Dow Jones Industrial Average swooned Tuesday and is staging only a cautious recovery today. The Wall Street Journal’s estimable David M. Wessel wrote, “The tectonic plates of the world economy are shifting, moving the yield on the 10-year Treasury to the highest level in more than a year and shaking financial markets from Tokyo to Mumbai and Johannesburg to São Paulo.” Is the world returning to something like normal, where America grows again, China does a soft landing to slower growth and the Japanese economy can finally find its footing?
Or is it a harbinger of more volatility in financial markets—perhaps the result of a misreading of the Federal Reserve’s policy intentions by the markets or a premature move by the Fed to cut back on easy money—that yields an unwelcome increase in market interest rates before the U.S. economy achieves what Fed Chairman Ben Bernanke once called ‘escape velocity’?
The question of what the Federal Reserve will do is rightfully a preoccupation. Can it make the pivot to slightly tighter money without tanking the markets? And can emerging markets continue to thrive on the “hot dollar” trade now that Treasuries are becoming more appealing? A couple of charts explain what is not happening.
As you can see, the Fed has done an astounding amount of stimulus since the Crash of 2008, not just keeping interest rates near zero, but also expanding the monetary base. But the red line shows inflation via the Consumer Price Index. So there’s no evidence that the rise in Treasury yields is a harbinger of runaway inflation.
More evidence comes from the chart above, which tracks the 10-year Treasury Inflation-Protected Securities (TIPS). This is the best way to guage investor sentiment about inflation. Although overall Treasury yields have begun to rise, and may affect the housing market, TIPS are barely above zero again. UC-Berkeley economist Brad DeLong comments: “When the 10-Year TIPS yield gets above 2.5%/year it might be time to start thinking about whether the long run in which the bond market wreaks its will upon the economy and constrains the Fed might be on the way. When the TIPS yield crosses zero? No way.” That hasn’t stopped JPMorgan from placing a big bet on rising rates.
So what’s going on? No question a more appealing Treasury yield will draw more investment to U.S. debt, and provide a bit of relief for those on fixed incomes. But the action is in Asia. Abenomics doesn’t seem to be working in Japan — or at least have the confidence of the markets. But more important, China is slowing with perhaps profound implications. There are assorted bubbles in China, too. Meanwhile, unemployment remains high and consumer demand weak in the United States. That makes any sudden change in Fed policy unlikely. And all that is predicated on no new major shocks to the global economy.
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Today’s Econ Haiku:
Feds check on bank risk
What? There’s gambling going on?
Shocked! (Revolving door)