The Depressing Signals the Markets Are Sending About the Global Economy

The Depressing Signals the Markets Are Sending About the Global Economy

By NEIL IRWIN

There are doubts that central banks and other policy makers can reverse worldwide deflationary forces.

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It wasn’t very long ago that the dread hovering over global financial markets was that things were getting too calm. Just this summer, Federal Reserve officials were fretting over markets being so stable that it might create complacency, and we were writing about a global boom in asset prices.

Even if many Americans don’t fully realize it yet, the autumn has brought a rather darker set of worries with a series of unnerving dives in financial markets across the globe. The American stock market has held up reasonably well, and the ups and downs of the Dow and S.&P. 500 play an outsize role in shaping American media coverage and American perceptions of the economy.

But many crucial indicators in markets for international bonds, currency and commodities are pointing toward a heightened risk of a worldwide economic slowdown that may be beyond the ability of policy makers to halt. It would inevitably have ripple effects even on the relatively strong American economy.

People who monitor the diverse global markets to understand what the future may hold are closely following these indicators.

Traders at the New York Stock Exchange on Tuesday. There have been a series of unnerving dives in financial markets across the globe. Credit Eduardo Munoz/Reuters

Bond yields. When the economic outlook becomes more gloomy, investors tend to pile money into government bonds of nations viewed as secure, creditworthy places to park money. Also, when the economic outlook appears worse, investors assume central banks will keep low interest rates in place for longer, so they must accept lower interest rates on even long-term bonds.

Long-Term Interest Rates Have Fallen in 2014

10-Year Treasury Bond Yield

These two factors together mean that the change in government bond yields of advanced countries works as a convenient proxy for whether economic expectations are becoming more optimistic or more pessimistic.

The signals are unambiguous. From the United States to Western Europe to Japan, long-term interest rates are falling.

Now consider the backdrop in the United States: Through the first three-quarters of 2014, job creation has steadily improved and the Federal Reserve has followed through on its plans to end the buying of long-term bonds this year (and has strongly signaled it will hike interest rates next year). You knew all that back in December, so you would have expected that interest rates would be steady or even up significantly this year. And you would have been very wrong: Ten-year Treasury bonds yielded 3 percent to start the year, a figure now down to 2.2 percent.

So something else is going on unrelated to the Fed or to the growth picture in the United States. And it seems to involve the outlook for inflation.

Inflation. We can gauge how much investors in the bond market expect prices to rise in the years ahead based on the difference in prices between regular bonds and those indexed to inflation. And that measure over the last few months has been pointing to a sharp drop in inflation expectations.

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Inflation Expectations Have Plummeted Since Summer

Using the difference between prices of bonds that are indexed to inflation and those that are not, we can gauge how much annual inflation investors expect in the years ahead.

Five-year break-even inflation rate

%

2.0

1.8

1.6

1.5%

January

February

March

April

May

June

July

August

September

October

Source: Bloomberg

But why would that be? After all, standard economic theory would suggest that if the economy is strengthening, it should push up inflation. Workers have a better shot at getting a raise now that the unemployment rate is under 6 percent than they did when it was double digits, for example.

That’s true, of course, but the United States is no island. And right now, there are some powerful forces pulling prices down from around the world.