Don't look now

Asset price disinflation may be next big thing

The great divergence may be about to come to an end. For investors in almost everything but the safest bonds, that is bad news.

The split between steadily rising asset prices and ever lower inflation in consumer prices has been one of the most noticeable economic features of the recovery from the 2008 financial crisis. For example, the MSCI World equity index was a third higher in July this year than just before Lehman Brothers failed.

The price of a barrel of Brent crude oil rose from $70-80 in 2010 to $110 in 2013 and through the first half of this year. Meanwhile, the US inflation rate fell from a pre-crash five per cent to three per cent in 2011, and is currently below two per cent.

The first sign of convergence between asset prices and inflation came in commodities. Iron ore peaked in February 2011 at $192 a tonne but is now below $80. Oil, by far the biggest commodity, only started to drop in June this year, but Brent has fallen 19 per cent in less than four months.

This looks like a trend. Property prices in hot markets like London, Paris and Shanghai seem to be out of steam. And now, stocks are getting on the bandwagon. The MSCI World index has fallen five per cent since its July 3 peak. The US S&P 500 index held out until mid-September, but has since fallen almost three per cent.

Monetary policy is the pat explanation. Markets are said to move up after, with, or in anticipation of changes in central bank policy.

Maybe, but the global disinflationary trend has survived several monetary cycles over several decades. Besides, global real interest rates remain ultra-low, even if the US Federal Reserve is moving closer to a rate increase.

Rather, it looks as if the tide of disinflation has overcome the obstacle of central bank resistance and is now flowing into asset markets. For investors, the loss of this bulwark is overwhelmingly negative. The exception is safe bonds, because money flows into them when other investments look bad. The yield on 10-year US Treasury bonds could fall far below the current 2.5 per cent.