Recent data releases show that Core inflation as measured by the Consumer Price Index, excluding food and energy, has been falling rapidly for 4 months now.  This is despite recently strong real consumption growth and despite the overall Consumer Price Index holding steady, see chart nearby.  Usually, at least in the past ten years, if one of these measures leads the other, it is the All Items measure leading the Core measure.  What may happen in the next few months is that the Core measure might pull down the All Items measure.   

Why would this be happening?  Could it be that domestic expenditure growth is decelerating?  We will not know this for a few weeks yet until April consumption data is released. 

If it is true that domestic demand growth is falling we have a number of potential concerns, the  first of which is that the recovery would be in jeopardy.  Just as serious though, if demand growth and Core prices both fall then we may be heading toward deflation. 

Deflation is particularly scary in the context of our current Macroeconomic situation: the fundamental weaknesses that exist would be exacerbated if households and firms stopped spending because they believe that prices are going to get cheaper.

Japan stepped up their purchases of United States Treasuries during October to $105 billion dollars, boosting their total holdings of United States Treasury Issues to $731 billion, more than 10 percent of the total market. Japan and China are typically the largest purchasers, by far, of United States Treasuries.

Why do we care about this? This helps keeps interest rates low and provides support for United States borrowing. It also maintains the many-decade-long pattern of relatively low United States savings rates and relatively high Asian-country savings rates.

There is another, more current, story behind this activity. Bond holdings are insurance against expected deflation. We here at CERF have been saying that the risk of United States Deflation is higher than risk of Inflation for six months now. It is now clear we are not the only ones with this opinion.