The Market's Measure
Inflation? Really?

Inflation? Really?

Fed expectations far ahead of the market.

Federal Reserve chair Janet Yellen said it. At long last, she said Thursday, inflation is set to hit the central bank’s target. Not now, mind you, but in the years to come. The Federal Open Market Committee (FOMC), the wizards behind the green curtain levering the nation’s money supply, has a long-standing inflation objective of two percent.

We’re nowhere near that now. In fact, the latest figures show inflation is still barely perceptible. The Consumer Price Index rose at a .2 percent annual rate in August. The chained Personal Consumption Expenditures index, the Fed’s favored inflation metric, ticked up at a 0.3 percent rate in August.

Those are small numbers. Yet they are higher than readings in the recent past. The CPI skittered and bounced below zero, in fact, in this year’s first trimester. You could say that inflation in this country has formed a bottom. Yellen seems to think this.

 

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In remarks made at the University of Massachusetts, Yellen said the FOMC “expects that inflation will gradually return to two percent over the next two or three years."

The Committee must expect inflation’s velocity to accelerate in a big way because, at its current speed, the PCE indicator would take eight years to exceed two percent. It’ll take more than four years for CPI to top two percent at its current pace.

The market’s expectation of inflation is a lot less sanguine. Take a look at the inflation rate implied in the Treasury market. The spread between five-year T-notes and TIPS is just 1.13 percent. Go out to the ten-year space and inflationary expectations sit at 1.46 percent. Ten years out and CPI’s still running under 1 1/2 percent?

 

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Keep in mind these are expectations, not guarantees. And expectations are volatile, as you can see.  At the nadir of the Great Recession, the ten-year forecast was an abysmal .04 percent. Staying above two percent has been touch-and-go ever since.

More “go” than “touch” in the past year, really. There’s a pretty sour mindset out there. It’s gonna take powerful economic ju-ju to grow inflation at the Fed’s desired pace.

 

Brad Zigler is REP./WealthManagement's Alternative Investments Editor. Previously, he was the head of marketing, research and education for the Pacific Exchange's (now NYSE Arca) option market and the iShares complex of exchange traded funds

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