The Week in Review: Low U.S. Inflation, Japanese Recession

Low inflation and exposure to weakening global markets is causing concern in the Federal Reserve, while a fall into recession in Japan is causing greater anxiety throughout Asia.

Low inflation and exposure to weakening global markets is causing concern in the Federal Reserve, while a fall into recession in Japan is causing greater anxiety throughout Asia.

More investors and economists are focusing on U.S. as a driver for global growth, thanks to strong and improving macroeconomic indicators, but greater uncertainty is mounting about Federal Reserve policy as inflation fails to reach the Fed’s 2% target. On Thursday, the Federal Reserve Bank of Cleveland announced that median Consumer Price Index (CPI) rose 0.2% in October, while the Bureau of Labor Statistics announced that the CPI was flat in October on lower energy costs. Excluding food and energy, the core CPI rose 0.2%.

U.S. Inflation Focus

Earlier in the week, the Federal Reserve announced that it grew increasingly concerned about deflationary pressures that were causing price growth to slow. The focus on inflation is a marked reversal of earlier Federal Reserve comments, in which a focus on labor market slack was guiding interest rate policy.

The Federal Open Market Committee announced this week that the Federal Reserve will “remain attentive to evidence of a possible downward shift in longer-term inflation expectations,” adding that U.S. growth was at risk of faltering due to a global slowdown in demand. While the Fed noted that consumer prices rose 1.4% in September, far short of the bank’s 2% target, a more recent measurement of producer prices showed that manufacturers and companies were seeing higher prices due to costlier services.

The 0.8% rise in PPI trade service costs offset a plunge in commodity prices. Processed foods, unprocessed energy materials, goods prices, and petroleum goods prices all fell both month-over-month and year-over-year in October. The steepest decline was in unprocessed crude petroleum, which fell 21.6% year-over-year in October.

Some economists believe that a convergence of declining energy costs, lessening slack in the labor market, and growing domestic demand could cause incomes to rise in 2015, which would further affect PPI while the CPI could still see muted growth.

Japan Contracts

Despite aggressive and growing monetary stimulus, Japan has fallen into a recession according to new data from the Bank of Japan. The Japanese economy shrank 0.4% in the third quarter of 2014, its second consecutive quarterly decline, with an annualized fall in GDP of 1.6%. Economists blame a rise in sales tax in April for the fall.

Domestic demand in Japan has remained weak, and economists believed that aggressive monetary stimulus that would raise the nation’s CPI could urge penny-pinching Japanese consumers to become spendthrifts. While consumer prices did rise 1% in the third quarter, which reversed a 15-year deflationary trend, it failed to encourage consumers to spend more.

Japanese Prime minster Shinzo Abe announced after the news that the government would delay its plans to raise the nation’s sales tax to 10% in 2015, and that he would call a snap election. Previously, the International Monetary Fund had encouraged Japan to raise its sales tax from 5% to 8% on fears that its aggressive monetary policy would cause investors to lose confidence, in turn leading to a lack of liquidity in Japan’s government bond market.

Despite the IMF’s warning, Japanese bonds have remained as popular as ever, with 10-year yields on Japanese government bonds falling 14 basis points year-over-year to 0.46% despite significant new issuances.