The Bond Market Is Telling Us Not to Worry About Inflation

(AT Express) -Back in early summer, the inflation hawks on the Federal Reserve’s rate-setting committee were trumpeting the latest pricing data as evidence that inflation was beginning to infect the economy. “The latest numbers suggest that inflation has bottomed out and is moving toward the committee’s target. I expect that firming trend to continue this year,” Jeffrey Lacker, president of the Federal Reserve Bank of Richmond, said in early July.

False alarm. Inflation has been trending lower since then. In August the Consumer Price Index actually fell 0.2 percent from July. It was flat, excluding volatile food and energy prices. What’s more, expectations of future inflation have been trending lower, as this chart shows.


The chart shows the yield of ordinary five-year Treasury bonds, which offer no protection against inflation, minus the yield of inflation-protected securities. The difference between them is approximately what people expect annual inflation to be over the next five years. Right now the gap is 1.7 percent, which is notably below the Fed’s target inflation rate of 2 percent.

Inflation expectations are so low that they’re actually turning into a bad thing, because they could signal to companies that the economy is softening and it’s a bad time to hire and invest. The U.S. isn’t yet Europe, where outright deflation is infecting parts of the euro zone, but it’s at risk. “Newspapers have well covered inflation falling too low in Europe, but the U.S. is now again joining the problem,” said a commentary issued on Friday by Kessler Investment Advisors of Denver.


Contrary to the hawks, Fed Chair Janet Yellen and others were saying back then that the uptick in inflation was likely to be brief. “Inflation lags economics by about 6 months, suggesting a period of slower inflation directly ahead,” Kessler wrote back in June.



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