Submitted by Bilal Hafeez of Nomura
While it’s fashionable to talk about the Japanification of Europe, the real story could be the Japanification of the US. Admittedly, the US doesn’t have as acute an aging population challenge or a current account surplus like Japan or the euro area, but it does have an inflation challenge.
Now with the Fed signalling a potential end to its hiking cycle and an actual end to its balance sheet reduction (QT tapering!), we are back to unconventional monetary policy territory. Markets are taking note – the market-implied real neutral rate or r* is approaching zero, a far cry from the 2% levels before the 2008 financial crisis. The equivalent in euro is actually below zero (see chart).
This means that the market doesn’t believe that either the Fed or the ECB will able to keep policy rates much above the inflation rate. Sounds eerily like Japan. This will also likely come back to haunt the dollar as it has a current deficit rather than a surplus.