Inflation Expectations Are Fading

Powell on Aug. 27 said that the central bank will sometimes allow inflation to run above the 2% target to make up for prior undershoots, and also let unemployment run lower than officials had previously tolerated.

But inflation expectations have already been fading.

Bond-market gauges of inflation expectations have declined for the past two weeks, signalling traders are demanding that Fed policy makers deliver more information about how they will engender a rise in inflation. Benchmark 10-year yields have fallen to below 0.70%, helped also by haven demand as lofty U.S. stock prices turned lower.

Ten-year breakeven inflation rates –- derived from yields on standard and inflation-linked Treasuries — have fallen for the last two weeks to about 1.67%. That’s down from an eight-month high of 1.82% reached on Sept. 1. Meanwhile, the gap between 5- and 30-year yields has edged down to 116 basis points, from as high as 125 basis points at the end of last month. Still, August’s core consumer price index, which excludes food and energy, came in higher than expected at 1.7% on a year-over-year basis on Sept. 11.

Benchmark 10-year Treasury yields have also booked two consecutive weeks of declines to hover at about 0.67%, possibly heading to 0.60%.

The Fed is buying about $80 billion of Treasuries and $40 billion in mortgage securities a month, both meant to sustain smooth market functioning after pandemic fears triggered a severe bout of illiquidity in March. Its Treasury purchases are being spread across the curve with no bias toward any particular maturity area.

Reference

Bloomberg, 2020-09-13, “Treasury Traders Are Doubtful Powell Can Drive Inflation Higher”