WSJ / Greg Ip -- Analysis: U.S. Risks Japanese-Style Growth Slump ......................
June 16, 2016
5:40 p.m. ET
Analysis: U.S. Risks Japanese-Style Growth Slump
Low bond yields suggest markets see entrenched economic problems that will be tough to overcome
By Greg Ip
When it comes to setting interest rates, bond markets stole the spotlight from central banks this week.
The Federal Reserve and the Bank of Japan left monetary policy unchanged, yet government bond yields plumbed fresh lows -- they went negative in Germany, further negative in Japan and hit three-year lows in the U.S.
Of the many reasons for this drop, three stand out: central banks’ efforts to stimulate economic growth with zero or negative short-term rates and bond buying; investors’ desire for safety, driven in great part by next week’s U.K. vote on whether to leave the European Union; and slowing economic growth around the world.
The first two are largely short-term phenomena. But the third is more intractable and therefore more worrisome. And it suggests the U.S. and many other countries are coming to resemble Japan, whose floundering economy has resisted two decades of resuscitation efforts.
Bond yields are determined by what investors expect short-term rates to be over the next decade plus some extra compensation, called the “term premium,” for locking their money up for so long. The term premium has historically averaged 0.5 to 2 percentage points. But Cornerstone Macro, an investment advisory, estimates it is now negative 0.6 percentage point in the U.S., negative 1.6 points in Germany and negative 1.7 points in Japan.
This is in part because central banks have bought bonds to reduce the supply and force investors to pay more and accept a lower yield. (Bond prices and yields move inversely.) The hope is that those lower yields will spur investment and push inflation higher toward the central banks’ 2% targets.
The negative term premium may also reflect fear. Government bonds are typically the safest asset available to investors. When disaster strikes, they usually rise in price as other assets such as stocks and corporate bonds fall. The U.S. financial crisis in 2008, the eurozone sovereign-debt crisis, the possibility of a Chinese economic slump, a massive terrorist attack or a pandemic have all enhanced this insurance value of bonds at various points. The risk du jour is a so-called Brexit; even a bond with no yield is a useful hedge against worst-case scenarios should Britain vote to leave the EU.
Fear doesn’t last forever, and neither does central-bank stimulus. Yet something more entrenched now also appears to be holding down interest rates, and the Fed’s decision Wednesday to lower the path of its future rate increases cast a spotlight on it.
The Fed has long assumed it would raise short-term rates to some neutral level that is compatible with full employment and stable inflation. But that number seems to be dropping; officials, who thought it was 4% in 2013, now think it’s 3%, and Fed Chairwoman Janet Yellen said Wednesday it might be 2%.
She usually blames the low neutral rate on “headwinds” such as the aftereffects of the 2008 financial crisis that would fade with time. But Wednesday, she cited “long-lasting or persistent” factors, such as aging societies and a global slump in productivity growth.
A slower-growing work force needs less equipment. Slow growth in productivity also leads to slower growth in wages and profits, which discourage households from borrowing (since they will have less future income with which to pay the money back) and firms from investing. In this way, sluggish growth can become self-reinforcing.
This may sound familiar because it’s what Japan has been going through since 1990. Back then, its economy was widely expected to continue growing at around 4% per year. But its working-age population peaked around 1995 and its productivity growth slowed. Since 1990, growth has averaged under 1%. Interest rates at zero and below have had limited effect at spurring business to invest more; they see their best growth prospects outside Japan.
Today, the effect on interest rates is compounded by the fact that labor-force growth and productivity growth have slowed in most major economies. Many emerging markets are coping with excess commodity-production capacity akin to the overhang of vacant homes the U.S. had in 2009.
Japanese policy makers have made matters worse by periodically raising taxes or interest rates in the premature belief that the growth was on the mend. One result is too-low inflation that has then required low rates for even longer. That is one mistake the Fed seems determined not to make.
Yet an aging population, slow productivity growth and the self-perpetuating pessimism that depresses business investment are much tougher challenges to overcome. And the verdict of the bond market is that they won’t be overcome soon.
Write to Greg Ip at greg.ip@wsj.com
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