Saturday, May 14, 2011

Inflation Expectations Are Falling in Bond Market

Based on the "breakeven rate," or the difference between 10-year nominal Treasury yields and 10-year Treasury Inflation Protected Securities (TIPS) yields, the bond market's expectation of future inflation has been falling over the last month, not rising.  After peaking at 2.65% on April 11, the breakeven rate has been gradually falling, and dropped below 2.40% yesterday (Friday) for the first time since March 23.  That's a 25 basis point drop in the breakeven rate over the last month. 

HTs: John Makin over lunch in the AEI dining room on Thursday, and Paul Krugman (see his post here).


At 5/14/2011 9:27 PM, Blogger Methinks said...

Sorry, I don't have the stomach for Krugman. Not going to read his column. He's rarely anything but a waste of time these days.

The dollar has been strengthening over the past 3 weeks (deflationary). Since that's a relative measure, let's see what else is happening....

Greece is 85% to default (last I checked) and that probability has been rising as the dollar has been (not coincidentally) getting stronger. There is talk of a second bailout and the whole thing spells bad news for Europe, contributing to slower global growth

Slower global growth and a relatively stronger U.S. currency means U.S. inflation is expected to be lower in the future. Let's see if the Fed launches QE 94 to change those expectations.

At 5/14/2011 11:49 PM, Blogger Benjamin Cole said...

Krugman is a smart guy, even if many disagree with him on many issues, as I do. And he obviously right on this one--the bond market says inflation is dead in the water.

So, the Chicken Little Inflation-conspiracy crowd has not yet convinced serious bond investors that runaway inflation is pending. Indeed, bond investors basically think there won't be any inflation, not now, not next year, and not for the next 10 years. The bond market may be telling us that the CPI overstates inflation by about one percent.

The bond market could be wrong. But with core inflation under two percent, with unit labor costs falling, with commercial rents soft, with M2 chugging along at 6 percent annual growth--where do you get inflation?

And commodities just topped off.

At 5/15/2011 8:32 AM, Blogger VangelV said...

It could well be that the bond market is predicting another top in equities that will bring money into debt instruments yielding less than the inflation rate. While that would be anther temporary win for bond holders who have been on the losing end for the past few years it is hardly anything more than a dead cat bounce driven by the difference in decay of the purchasing power of fiat currencies. Once the bounce in the USD is over and the games in the futures markets end we will be back to where we were a few months ago as Helicopter Ben is up to his old tricks and buying treasuries to get Obama and most of the current members of Congress reelected.

The one thing that interests me even more at this point is the debate in Ireland. If the Irish people do what they should, which is cut the big private banks loose and leave the European lenders to those banks deal with the bad loans, we could see the beginning of the end for the current post-Bretton Woods system.

At 5/15/2011 2:36 PM, Blogger juandos said...

TIPS, a 15 cent bandaid on a $15 trillion hemorrhage?

At 5/15/2011 8:56 PM, Blogger Michael E. Marotta said...

As the bond market is the primary engine of inflation, I am not sure what this means. Perhaps it is a chart for "Taxpayer Futures."

At 5/16/2011 9:16 AM, Blogger morganovich said...

TIPS are based on CPI, not inflation.

if you do not believe CPI, then you would never use tips to hedge inflation.

also note that the bond market is rallying because of the debt ceiling being reached.

no new bonds = higher value for the existing ones.

it will interesting to see how the fed plays this. will they keep running QE2 in the open markets?


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