Do the world's major central banks have what it takes to move the needle on inflation?
The inability to generate inflation through both conventional and unconventional means is a maddening conundrum for central bankers worldwide. Even the European Central Bank’s (ECB) unprecedented, once-unimaginable policy of a negative nominal deposit facility interest rate of -0.40% has failed to make a meaningful dent in prices.
At the beginning of 2018, the Federal Reserve (Fed) and the ECB both concluded that growth-led inflation was strong enough to allow the normalization of post-crisis stimulus policies. But in the face of mixed data, both institutions have reversed course. Comments from the Fed turned conspicuously dovish -- a surprising development given the strong fiscal boost to the U.S. economy over the past two years. In Europe, the ECB has doubled down on its conviction that negative rates will bring about positive inflation in Europe.
Chronically Below-Target Core Inflation is a Global Phenomenon
Chart courtesy of Western Asset. Source: Bureau of Economic Analysis, Bloomberg, as of 30 April 2019. Past performance is no guarantee of future results. This information is provided for illustrative purposes only and does not reflect the performance of an actual investment.
For many, it’s now a given that rates will be managed downward. Paradoxically, just as inflation-adjusted yield has become easier to achieve (as inflation itself remains subdued), demand for investments with an even stronger nominal yield has spiked. That’s cold comfort for investors dependent on financial markets to supply income, as the quest for higher yield has driven some to incur more risk than they might otherwise have considered.
On the rise: U.S. 3-year Treasury Yields
Though the U.S. Treasury yield curve remains inverted for maturities between 3 months and 3 years, it’s worth noting the 15 basis-point rise in yield of the 3-year over the past week.1
The shape of the yield curve continues to attract attention as a predictor of recession. But one possible explanation of the rise of the 3-year argues against the worry. The most recent monthly jobs report this past week sent a strong signal that economic growth is still robust, leading Fed-watchers to forecast a decreased number – and size – of rate cuts they expect to see from the Federal Open Market in the rest of 2019.
It should be noted that a true, full-fledged yield curve inversion has yet to occur; at 2.5411%, the 30-year yield remains measurably above the 2.432% yield of the 3-month Treasury and has not fallen below any of the shorter-dated yields since the current round of worries about the onset of a recession over the past few months began. Which is not to say it can’t move back in that direction; “not yet” isn’t the same as “won’t happen”.
On the slide: British pound vs. the U.S. Dollar
At $1.246 per U.S. dollar, the pound has fallen some -6.5%, or 8.76 U.S. cents, since mid-March. The majority of the fall took place in May, paralleling the falling political fortunes of the eponymous Prime Minister.
The political scrum both within the Conservative Party -- and between it and the seemingly more-united Labour Party -- have probably not helped. Neither has the prospect of a general election pitting two high-profile but controversial candidates (Boris Johnson and Jeremy Corbyn) against one another as the October 31 deadline for Brexit approaches.
All data Source: Bloomberg as of July 9, 2019 unless otherwise specified.
1 Source: Bloomberg, July 9, 2019, 5:00 PM ET
The Federal Open Market Committee (FOMC) is a policy-making body of the Federal Reserve System responsible for the formulation of a policy designed to promote economic growth, full employment, stable prices, and a sustainable pattern of international trade and payments.
U.S. Treasuries are direct debt obligations issued and backed by the "full faith and credit" of the U.S. government. The U.S. government guarantees the principal and interest payments on U.S. Treasuries when the securities are held to maturity. Unlike U.S. Treasury securities, debt securities issued by the federal agencies and instrumentalities and related investments may or may not be backed by the full faith and credit of the U.S. government. Even when the U.S. government guarantees principal and interest payments on securities, this guarantee does not apply to losses resulting from declines in the market value of these securities.
The Federal Reserve Board ("Fed") is responsible for the formulation of U.S. policies designed to promote economic growth, full employment, stable prices, and a sustainable pattern of international trade and payments.
The Personal Consumption Expenditures (PCE) Price Index is a measure of price changes in consumer goods and services; the measure includes data pertaining to durables, non-durables and services. This index takes consumers' changing consumption due to prices into account, whereas the Consumer Price Index uses a fixed basket of goods with weightings that do not change over time. Core PCE excludes food & energy prices.
One basis point (bps) equals one one-hundredth of a percentage point.
The yield curve shows the relationship between yields and maturity dates for a similar class of bonds.
Inverted yield curve refers to a market condition when yields for longer-maturity bonds have yields which are lower than shorter-maturity issues.