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Earlier today the headline *GERMAN TWO-YEAR NOTE YIELD DROPS BELOW JAPAN'S FOR FIRST TIME* hit the wires and yes currently sitting at below 0.1%, it is indeed very close to turning negative. As illustrated below it took 20 years for the German Bund to go Japanese so forgive me for trying to make a comparison.

  • German 2 year yield drops below Japan's for the first time


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Much has been written about the U.S. economy going Japanese and there are indeed some worrying signs. And for all the Bernanke bashing, that is one thing he really understands and will fight aggressively.

Unfortunately, eurozone policymakers and the German's inflation Phobia are making all they can for Europe to get into an entrenched deflationary spiral.

Well illustrated below via FTAlphaville every time there is the slightest form of relief the Bundesbank calls for an exit strategy!

  • Bundesbank making sure Spanish yields do not come in.


(Click to enlarge)

And listening to the likes of Axel Weber or its successors you might think inflation for Europe "as a whole" to quote JC Trichet is in runaway mode. Well it is not. It is like it is the case for German bond yields and in fact many things in the eurozone sitting at a Japanese style 20 year low.

  • Eurozone Core Inflation at 20 years low


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Since there no real signs of inflation, the German Hawks say that you cannot inject such liquidity in the system without creating runaway inflation at some point.

Well for all those trillions injected and that explosion in the monetary base, Money Supply growth M2 for the eurozone is also sitting at a multi decade low. And as you can see in the chart below, the white line and white circle shows the Money Supply crash Japan experienced in the 90s while the orange line and red circle shows the EXACT same thing happening to the EU M2 growth in 2008.

Guess what, in Japan it never came back!

  • Eurozone M2 growth crashed in the exact same way that Japanese money supply did in the 90s.


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The ECB policy is not creating asset bubbles either. In the eurozone as whole as real estate is horrendous ...

  • FTSE EUROFISRT REAL ESTATE INDEX


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while Equities are in Total NIKKEI mode:

  • EURO STOXX 50


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And no, not even in Germany have inflation expectations run out of control. They are well in check and in fact well below the ECB or Bundesbank mandates and going lower ...

  • German 10 year inflation expectations (break evens)


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And no the economy is not showing signs of overheating ... leading indicators appear to be rolling over while already sitting at a decade low ...

  • EU leading indicator


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and PMIs are already below 50 ...

  • EUROZONE PMI


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And to those who think Germany's economy is overheating, its latest PMI was also below 50 and even below the eurozone average "as a whole."

  • German PMI


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And it is no surprise since most of Germany's exports are going to the eurozone itself ...

So yes, I do think the savage austerity and the Bundesbank members lack of solidarity could push the eurozone into deflation.

In fact, it looks like it has started already and this is probably why the EURO is resilient despite the increasing risk premium. Because, as we have explained on many occasions, should the eurozone go Japanese, deflation would cause both Real Interest Rates and the Euro to spike.

Source: The Eurozone Is Turning Japanese