Deflationary Forces Strengthen

The month and week are winding down, and what a month and week it has been. The three key events were all about Europe. The SNB’s unexpected decision to lift the cap on the franc. The ECB’s decision to proceed with a sovereign bond buying program was less a surprise but just as momentous if not more so. Syriza’s victory in Greece is already changing the political landscape. 

Negative nominal rates, unthinkable  eighteen months ago, have become more common. And if zero is not the bottom of nominal interest rates, how low can rates go? The SNB has its target rate at -0.75%. Look at what else has happened. Italy sold ten-year bonds this week at record low yields.  Ireland yesterday auctioned T-bills at zero interest rates. German yields are negative through five years and the 30-year bond yield today is just above 1%. When assessing the cost of its aid to the periphery, shouldn’t we deduct the interest rate savings?  

As more senior European officials meet with the new Greek government two things are becoming more apparent. First, the government is not taking unilateral action.  Second, it does have a different perspective and interests that it will express and have to be accommodated to some extent. For example, new sanctions on Russia require unanimity. At first it appeared that Greece was going to block new sanctions. A compromise was worked out.  

Today there is talk of extending the current “extension” of the existing assistance programs as long as six months  (through August). We have suggested a small extension was possible.  It was not the cynical “pretend and extend” but it was a practical solution.  Six months seems too long though for both sides–the Greek government as well as the official creditors. That said Greek bonds are extending yesterday’s recovery.  

There were three inflation reports today. First Japan, where the BOJ is expanding its balance sheet by 1.4% of GDP a month, reported that inflation continues to move in the wrong direction. The BOJ’s target, core inflation, which excludes food but not energy, adjusted for the sales tax increase last April slipped to 0.5% from 0.7% and is the third month below 1%.