Inflation it seems is hard to come by. ECB President Mario Draghi knows this from the December flash estimate this week that shows that the Eurozone is in deflation (-0.2% year-over-year). In fact the “disinflation” theme (falling, but positive inflation) is a generally global phenomenon. As can be seen in the chart, most of the world’s major economies and regions faced a significant decrease in the price of consumer goods in the past year. This contributed to the seemingly odd circumstance of a Spanish or Italian government bond having a lower nominal yield than the US (1.6% and 1.4% respectively versus the US 2%, essentially the “real yield in the US is higher due to deflation in those economies). Pressure is again on the ECB to (finally) do something at their January 22nd meeting. A whisper was heard today that the number may be €500bln – €600bln. The EUR/USD has been our indicator for market confidence in action – while it is already down another 2% year-to-date it bounced a bit today. Is it enough?
The inflation issue is no less relevant for Asia. Japan aside (increase is driven by the one-time pass through of the sales tax hike in April), emerging Asia has seen inflation fall below targeted levels. Policy response on all fronts will be forthcoming. Fiscal stimulus in China is already ramping up to combat the 1% gap between the actual and desired level. Many emerging central banks who were quick to raise rates in the early recovery (2009/2010) will likely start to reduce rates causing the cost of locally sourced capital to fall while also creating further currency weakness versus the US Dollar.
Given the divergence between regions of growth, inflation, and currency, it is only logical that we see a policy response from the world’s central banks to this disinflationary trap. Collectively, they have spent so much money and political power to avoid deflation that may not have the bullets to do it again.