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Investing Specialists

Deflation, the New Biggest Worry

Low inflation rates in Europe are raising alarm bells around the world.

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This week's expected data deluge was a bust, with a lot of the key reports moved a week later, perhaps because of the Veterans Day holiday. Markets in general were up as Fed speakers and Fed chair nominee Janet Yellen's confirmation testimony seemed to suggest that no one was in a great rush to begin tapering bond purchases.

The inverse correlation between tapering prospects and stock market performance continues. Unless the U.S. economy falls apart, I strongly believe that tapering will begin sometime in the next seven months. However, the resulting increase in long-term interest rates is likely to be relatively small compared with the current 2.71% rate on the 10-year Treasury bond. That is especially true as inflation remains remarkably subdued and is pushing uncomfortably close to deflation. As highlighted later in this report, year-over-year inflation dipped to 0.7% in the eurozone for the month of October. The U.S. CPI report is due next week and that is expected to show no change month to month, and even the year-over-year data point looks like inflation will be up only 1.0%. Interest rates are usually a function of inflation plus a spread, and now the base rate seems to be lower than we all imagined just a few months ago.

Robert Johnson, CFA does not own (actual or beneficial) shares in any of the securities mentioned above. Find out about Morningstar’s editorial policies.