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The Message of the 2yr Treasury, Deflation, and Japan

Posted by Larry Doyle on November 20, 2009 2:20 PM |

Most eyes are fixated on the rise in equities and commodities and, in turn, point to those markets as indicators of an incipient economic recovery. In doing so, we neglect the movements within the bond market, specifically the U.S. Treasury market, at our peril. What is the Treasury market saying? A lot. Let’s look and listen.

The 2yr Treasury note specifically yields a paltry-like .71%. Why so little? I thought investors were more inclined to invest in risk-based assets? Why are they buying a 2yr Treasury note at such a miniscule return?

In my opinion, the front end of the Treasury curve, typically referenced by the yield on the 2yr note, is telling us the Fed will be on hold for a protracted period. This point we already knew. Tell me something I don’t know, LD. The 2yr Treasury note is indicating that inflation expectations are currently constrained. You probably knew that, also. Two strikes LD, you get one more pitch. The 2yr Treasury specifically and bonds in general are telling me that deflationary pressures in our economy are growing. What do you think? While most economists and analysts talk about inflation and inflation expectations, we have not heard much about deflation lately. Welcome to Sense on Cents.

Today we learn Japan’s economy is again experiencing deflation. The Financial Times highlights this development in writing, Japan Says Economy Back in Deflation:

The Bank of Japan moved towards a neutral stance on the risk of inflation on Friday even as the government formally declared that the world’s second-largest economy has entered deflation for the first time since 2006.

The government’s declaration sets the scene for heightened tension with the bank, which has been resisting public calls by politicians for greater aggression in the fight against deflation.

“We want the BoJ to extend support on the monetary policy front in overcoming deflation,” said Naoto Kan, deputy prime minister. Hirohisa Fujii, finance minister, and Shizuka Kamei, financial services minister, have also called on the central bank to do more.

The basic difference between the bank and the government is whether or not looser monetary policy can create inflation when factories are standing idle and there is limited demand to borrow.

Don’t think for a second that Bernanke and Geithner aren’t primarily concerned with the prospects of a deflationary cycle here in the United States and are trying to create inflation while risking the value of our greenback in the process. Idle factories? Limited demand to borrow? Yes, Japan has plenty of that – as does America.

This is the real message of the 2yr Treasury.

For serious ‘navigators’ who would like to venture into a world of increasing deflationary prospects, I submit a lengthy treatise (linked image provided at end of this commentary) produced by Societe Generale entitled, “Worst-Case Debt Scenario.”  The provides a glimpse of this report in writing, Societe Generale Tells Clients How to Prepare for Potential ‘Global Collapse’:

In a report entitled “Worst-case debt scenario”, the bank’s asset team said state rescue packages over the last year have merely transferred private liabilities onto sagging sovereign shoulders, creating a fresh set of problems.

Overall debt is still far too high in almost all rich economies as a share of GDP (350pc in the US), whether public or private. It must be reduced by the hard slog of “deleveraging”, for years.

“As yet, nobody can say with any certainty whether we have in fact escaped the prospect of a global economic collapse,” said the 68-page report, headed by asset chief Daniel Fermon. It is an exploration of the dangers, not a forecast.

Pack lightly just in case.


Click on image to access pdf document of the report:


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