Gavekal Capital: US Losing Currency War

Friday, April 11, 2014

US Losing Currency War

One of things that has gotten some attention lately is the spread compression in the long end of the yield curve.  This looks to us like a classic deflationary configuration.  Consider that: 1) nominal rates have been falling for both the 10 and 30 year bonds and 2) while nominal spreads have dropped by 37bps since last April, the inflation spread (or simply the spread between 10 and 30 year inflation expectations) has dropped by 51bps.  This suggest to us that over 100% of the compression in long bond spreads is due to falling inflation expectations.  This evidence points more toward the secular stagnation hypothesis of the US rather than the growth resurgence.


What is the source of these deflationary pressures?  There are at least three we can identify: 1) despite the massive amounts of QE, the US never really experienced much of a currency devaluation and surge in inflation expectations, 2) the Fed is moving to taper without having propped inflation expectations enough and 3) the US has been getting crushed in the currency was for the last year.

A good example of the third point is Japan, who was been doing massive QE in the last year.  In the chart below, we plot the USD/Yen against the nominal spread between 30/10 year US Treasury bonds.  The drop in the 30/10 spread has largely been a function of the latest battle in the currency was.  If rising inflation expectations, rising rates and falling currency are by-products of a successful battle in the global currency war, then the US has clearly been on the losing end for over a year now.