US: Is the US close to deflation?

The decline in yields of U.S. Treasury bonds at historically low levels surely satisfies the Obama administration, which despite a surge in the budget deficit to high levels still hold the power borrow at low cost from the markets. Analysts, however, indicate that this trend would likely to worry the U.S. Treasury, and reveals that the markets believe that the biggest economy in the world is too close to deflation.

Even the Federal Reserved’s decision to support by issuing additional measures for the economic recovery, instead of stop the decline in yields it could reinforce it. The interest rate on U.S. Treasury bonds for ten-year duration, which had reached almost to 4% in April, dropped to 2.60%. According to the Wall Street Journal, the day the Fed announced that it will offer some relaxation measures; yields on ten-year bonds have fallen by 0.22%.

This is because the support to the economy from central bank will be in the form of government bonds. The larger volume of bonds purchased by the Fed the more intense is likely to be the pressure on government bonds yields. However, if the investors had confidence in the prospects for recovery and the course of consumer prices the yields will not had fallen. So far, inflation remains in positive sign but at extremely low levels (0.9 %).

If the estimations for further increase in unemployment over the coming months confirmed, then this will lead the inflation rate to fall further as consumers will limit their spending to what is absolutely necessary. Both the Treasury and the Fed seem to recognize the danger of deflation, however, they haven’t convinced yet that they can apply the right measures in order to reverse the tendency of the markets.

It should however be noted that a number of analysts believes that the concerns about excessive deflation are overvalued. Consumer spending, although under pressure, remains at levels much better than Japan, where consumer price index is negative. Furthermore, the yields of Japanese government bonds of ten-year duration are now below 1%, lower by 150 base points than the American government bonds.