Global bond market forecasts continual low inflation

By Neil Behrmann

April, 05:- Those who believe that inflation is about to take off had better examine trends in the US$38 trillion global bond market.

Long term bond prices, which are intricately linked to inflation expectations, have shrugged off pessimistic forecasts of economists. In the past year, ten year US Treasury bond yields have fluctuated between 4 to 4.5 per cent. Meanwhile recession in Germany has caused ten year bond yields there to tumble to 3.7 per cent. UK government bond yields are 4.7 per cent and Japanese yields are only 1.4 per cent. These low yields, which are close to levels seen in the stable economic period of the 1950's, are saying that at worst any inflation acceleration will be temporary and mild. Indeed inflation could decline once again in 2006.

In contrast to bond market investors, many economic and financial forecasters have been predicting that inflation will accelerate. Economic expansion, relatively low interest rates, the slide of the US dollar and surge in energy prices and other commodities were bound to cause an inflation problem, especially in the US. Long term US and global bond prices would slump and their yields would surge, economists predicted.

So far, however, the main long term bond investors, notably pension funds and insurance companies, have outplayed most economists. They have taken the view that real, inflation adjusted yields, will remain positive in the long term. Indeed even though long term bond yields are historically low, they are still exceeding inflation. In the 12 months ended December 2004, consumer price increases of the 30 member nations of the Organisation For Economic Cooperation And Development (OECD) rose by only 2.8 per cent. This stability is impressive considering that consumer energy prices surged by 11 per cent last year and were on a rising trend in 2003. Last year US consumer prices rose by 3.3 per cent, the UK by 3.5 per cent, Germany and France by 2.1 per cent and Italy by 1.9 per cent, according to the OECD. Japan's consumer prices rose by 0.2 percent, while Singapore's consumer prices were up by only 1.5 per cent and China and Korea by 2.4 per cent and 3.1 per cent respectively.

Using other measures such as the Federal Reserve Board's Personal Consumption Expenditure (PCE) price index, year on year core inflation is around 1.5 per cent in the US. This implies that the real inflation adjusted ten year treasury yield is 2.5 per cent. Other inflation measures, notably the OECD's gross domestic product deflator state that Japan continues to be mired in deflation, so Japanese real long bond yields are 1.5 to 2 per cent.

Granted, there has been mild inflation acceleration in the US and countries
such as China. Nevertheless the bond market has a good chance to win the
2005 forecasting race again:

            

Dec 98

May 99

May 00

June 01

Nov 01

May 02

Jul 02

Sep 02

June 03

Apr 05

US 4.25 5.64 6.38 5.35 4.34 5.20 4.81 3.65  3.04  4.27

Germany

3.70

4.15

5.28

5.07

4.34

5.20

5.00

4.26

3.40

3.45

UK

4.30

4.94

5.30

5.17

4.51

5.28

5.10

4.36

3.48

4.58

Japan

0.84

1.17

1.66

1.22

1.31

1.40

1.32

1.28

0.43

1.26

Canada

4.68

5.75

6.70

 5.75

5.02

5.69

5.54

4.80

3.98

4.16

Australia

4.90

6.06

6.47

 6.04

5.15

6.28

6.07

5.33

4.60

5.36

NZealand

5.40

6.36

6.63

 6.75

6.13

6.90

6.66

5.96

5.04

5.98

 

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