My, How Inflation Expectations Have Fallen in December 2014!

December 22nd, 2014 by 
PK

In this shortened workweek, we move our attention to the recent 'breakdown' of inflation expectations, or as they have taken to be called in the financial media, "break-evens".  For an explanation of that term, I'll point you to the audio version of yours truly (on the Stacking Benjamins Podcast) discussing how various securities can reveal the market's inflation expectations.

Anyway, the reason we are turning back to this topic?  Even with improved employment, we're still waiting for wages to take off in earnest - and, by theory, increasing wages are an inflationary pressure.  Since break-evens have actually fallen recently, we turn our eyes to the drop!

Inflation Expectations Over 5, 10, 20, and 30 Years.

To reproduce this chart, either search breakevens on FRED, or go straight to the source at the US Treasury and subtract real yields from the Treasury yield curve.  Since inflation protected securities will pay off plus inflation, that hidden inflation variable is what is revealed using this method.

Here's what inflation expectations have done this month:

December 2014 Inflation Expectations
Look at that Precipitous Drop!!

Okay, maybe that's a little scary to see everything tilt back towards the deflation side.  Of course, we're only looking at a brief snapshot... let's see if a longer history does anything for us!

2003 to Present Inflation Expectations
Huh, Maybe It's Not So Bad?

Sure, we're cheer-leading a recovery at this point - but we're seeing inflation expectations we haven't seen since... 2003.

Now, obviously, this series doesn't go back long enough to draw any meaningful conclusions... but a slow downhill decline (which can hopefully be arrested) is much better than the cliff we fell off in 2008.

And, hey, the market is expecting less inflation in the midst of what seems to be a strengthening recovery.  Let's monitor it but not panic yet, eh?

How much money is under your mattress?  Are you worried about inflation coming in incredibly low the next five years?  What's the ideal rate of inflation in an advanced economy?  ow will this affect your investing?

      

PK

PK started DQYDJ in 2009 to research and discuss finance and investing and help answer financial questions. He's expanded DQYDJ to build visualizations, calculators, and interactive tools.

PK lives in New Hampshire with his wife, kids, and dog.

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