Persistent economic weakness in Japan and the eurozone could save the U.S. from higher interest rates as its economy rebounds strongly from the Covid-19 recession.
Rising inflation and interest rates have captured Wall Street headlines in recent weeks. The Producer Price Index —a measure of inflation at the wholesale level—rose 2.8% from a year earlier in February 2021, following a 1.7% increase in January, the most significant advance since October 2018. The Consumer Price Index—a measure of inflation at the retail level— rose 0.4% from January and 1.7% from a year earlier.
Higher inflation numbers pushed the yield on the benchmark 10-year Treasury note to 1.669%, up from 0.55% last August.
| Country | PPI | CPI | 10-year T-bond yield |
| USA | 2.8% | 1.7% | 1.69% |
| Eurozone | 0.8 | 0.90 | -0.39* |
| Japan | -0.70 | -0.40 | 0.08 |
*Germany
How much higher will inflation and interest rates go from these levels? Some see the return of the 1960s-style inflation (demand-pull inflation), driven by monetary and fiscal easing, which pushes prices higher as the economy recovers from the pandemic, and the economic stimulus takes full effect.
Others see the return of early 1970s-style inflation (cost-push inflation), driven by a spike in wages, raw materials and energy prices due to supply chain bottlenecks created by the pandemic.
Both scenarios mean higher interest rates and big trouble for risky assets on Wall Street, which have to be repriced to reflect the higher interest rates.
But both scenarios are unlikely, as the rest of the developed world remains weak. The eurozone, a slow-growing area even before the Covid-19 crisis, is still under lockdowns, limiting any rebounds in the near term. Japan is still striving to get out of a three-decade-long stagnation.
Weak growth in the rest of the developed world means low inflation and low interest rates. The eurozone's most recent inflation numbers are below 1%, while Japan's numbers are negative (deflation).
Low inflation numbers mean low-interest rates—near zero in Japan and negative in Germany—and a strong incentive for European and Japanese investors to buy U.S. Treasuries.
We all know what that means: Europe and Japan could soon save the U.S. from higher interest rates.
Read more here:
- A Rising Interest Rate Spread Could Give Banks a Big Boost
- How the SPAC Bubble Will Burst
- The Fed Should Mind the Gap
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