We updated our (long ongoing) inflation expectation series right after the Federal Reserve raised rates for the first time since 2006, when all breakeven rates up to 30 years out were topping out at less than 1.7% for a year. So, let’s update our readers again – especially you US Government debt buyers and especially all the TIPs fans in the audience.
As a refresher, breakeven rates are what you get when you subtract the yield on instruments which adjust for inflation – say, CPI – from the rates on other, non-adjusted securities. The number you are left with is what the ‘market’ expects CPI to come in at, since that is where the inflation protected securities will match the nominal securities.
(But first, a long caveat – you can’t always exactly trade these breakevens depending on when treasuries mature – but you can usually come close by trading on the secondary market, within a couple months. The general trade would be to buy inflation protected securities like TIPS if you think breakevens are too low, and buying normal, non-inflation adjusted treasuries in the case you think inflation expectations are too high. All the other disclaimers apply – figure out how taxes, transaction fees, and everything else affects your trade, but that’s the gist!)
Charting Treasury Breakevens
First, let’s show how break-evens have looked since February began:
And, for context, a longer run zoomed out chart since the beginning of 2014:
|Date||5 yr||7 yr||10 yr||20 yr||30 yr|
Will Inflation Ever Come Back?
As you all know, the Federal Reserve targets around 2% inflation or so when setting monetary policy. As you also know, breakevens themselves aren’t perfect proxies for what the market expects in inflation due to slippage, liquidity, taxes and other issues (as in past posts on this topic, please see the Cleveland Fed’s estimates for an alternative series).
That said, lowered inflation expectations in general have huge implications for policy – including the fact that inflation is what allows central banks to have “negative rates” without going negative – so 1% rates in an era of 4% inflation are really “negative 3% rates”. It’s this environment in which we find ourselves… an environment which has seen many countries already playing with negative rates. Another alternative in the face of low inflation or deflation is, of course, Quantitative Easing.
So, in a way, you should be rooting for numbers to come in higher than what we’re seeing – even though that seems a little bit backwards to your bottom line – that’s just where all of the models have been worked out!
But let us know what you think in the comments – do you expect more or less inflation that the breakeven rates? Could you see us only averaging 1.50% annual inflation for a generation? Anything else stick out to you?