Inflation is everywhere. China’s manufacturing prices, a wide range of commodity prices, and consumer prices for commodities ranging from fruits to freezers are rising. Everywhere, that is, except in the bond market.
The five-year inflation breakeven (the difference between a regular five-year Treasury yield and an inflation-protected yield) is about the same as it was three months ago. Last month, when the inflation debate was the hottest, they actually declined.
Also, it is not particularly high by historical standards. At around 2.47% annually over the next five years, inflation currently priced in bond markets has been above historical levels during most of the low inflation periods following the 2008 financial crisis. But from 2004 to 2007, when inflation wasn’t booming, that level was perfectly normal.
Bond yields are far from the general relationship with inflation over the last three and a half years, Nordea analysts say. The 3.8% core consumer price index, reported Thursday, has never been recorded in the period since 1985, alongside 10-year bond yields of less than 6%. This shows a fairly overwhelming belief on the part of investors that inflation is temporary.
How good is the bond market in predicting inflation? Joseph Gagnon, Senior Fellow of the Peterson Institute for International Economics, said that while much of the data used was before the existence of inflation-indexed bonds, yields are much more closely related to past inflation than to future inflation. It suggests that there is.
But with that in mind, investors are making big bets because the value of bonds will fall if something like the normal historical relationship between inflation and yields resumes. Much consists of the Fed’s activities in the Treasury market, but the central bank owns only about 25% of the total. Most are in the hands of investors who are in a position to lose money on sale.
Another prediction is mixed bags. Headline inflation averages 2.4% over the next five years and 2.3% over the next decade, according to the latest survey of professional forecasters from the Federal Reserve Board of Philadelphia, released in May. Is very consistent with. This week, the University of Chicago Booth Business School also released a survey of economic experts on the risks of overheating and inflation. This shows a rough balance between the view that the economy is overheating and the view that it is not, but it is not a strong position where many have expressed uncertainty.
Clearly, there are a minority of investors in the market who are predicting damaging levels of inflation, even if the signal from the bond market is incomplete. Pricing is currently almost exactly what the Federal Reserve is looking for. If 1970s-style inflation is actually included in the card, those who haven’t properly placed their portfolio can at least be reassured by the knowledge that most of their peers haven’t.
Write to Mike Bird at Mike.Bird@wsj.com
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What does the bond market know about inflation?
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