Sees "Reverse Last Chance This Century"
The year 2015 could be a mirror image of the year 1981, when highly restrictive policies by the U.S. Federal Reserve ended a prolonged uptrend in inflation, according to BNY Mellon Chief Economist Richard Hoey. Hoey made the comments in his March 25 commentary, State of the Debate.
Yields peaked in 1981 when anti-inflationary policy under Paul Volcker, then the chairman of the Federal Reserve, was aggressive enough to halt the uptrend in inflation. Hoey believes that today's anti-deflationary policies by central banks will prove aggressive enough to overcome today's risks of deflation, disinflation and lowflation. He believes that this means that the year 2015 is likely to mark both a bottom in inflation and the end of the long secular decline in bond yields. This may result in a transition from the "coupon plus" bond market of current yield plus capital gains on bonds over much of the last three decades to a "coupon minus" bond market.
This is an echo of his Forbes magazine column in 1981 titled Last Chance This Century, in which he stated, "I personally believe that the peak in long-term interest rates reached during 1981 is likely to stand for at least the next century." Hoey describes a likely mirror image opposite pattern in 2015 as bottoming inflation and bond yields as a "reverse Last Chance This Century."
"The central banks have placed such a priority on fighting deflation risks that they are accepting the risk of asset bubbles in order to generate an upward shift in current spending," Hoey said. "Given the intensity of the banks' anti-deflationary policies, higher inflation should return, although not for a while." Overall, Hoey said he expects a gradual normalization of inflation rather than upsurge to excessive inflation.
The legacy of excess capacity in many countries that resulted from the Great Recession is a key reason for the low inflation today, despite the low interest rates and quantitative easing, the report said. The report notes that it has taken time to work off this capacity. In addition increased financial regulations that were motivated by the recession have slowed the response to monetary policy, the report said.
Hoey is optimistic about the prospects for a long expansion in the world economy, although he said that he expects gross domestic product growth to be on a lower path than before the recession. "This expectation results from a one-time downshift in growth from the effect of the Great Recession plus deteriorating demographics that reflect a decelerating growth rate for the working-age population in many countries," he said. "Also, we're seeing suboptimal economic policies in many countries."