Downsizing The Treasury Market’s Inflation Forecast

Inflation expectations in the US are sliding again, raising new concerns about the economic outlook. Perhaps today’s update on consumer prices for December (due out at 8:30 am eastern) will allay fears that disinflation risk has reaccelerated. Meantime, Mr. Market has been lowering his outlook for pricing pressure… again.

The yield spread on nominal less inflation-indexed 10-year Treasuries dipped to 1.36% last Friday (Jan. 15)—a six-year low, based on daily data from Treasury.gov. The market’s implied inflation forecast rebounded a bit yesterday, ticking up to 1.38%. But it’s clear that expectations for the future path of inflation are again moving in a worrisome direction.

Meanwhile, the yield curve has shifted down across the maturity spectrum. Other than the short end of the curve, where the Fed’s influence is greatest, there’s been a decline in yields over the past 30 trading days through Jan. 19–from the 6-month maturity up to the 30-years (black line in chart below).

Recent comments from two Fed officials have helped fan the flames for worrying about a new phase of disinflation risk. “Headline inflation will return to target once oil prices stabilize, but recent further declines in global oil prices are calling into question when such a stabilization may occur,” noted St. Louis Fed President James Bullard last week. Meanwhile, Chicago Fed President Charles Evans on Jan. 13 observed that by some accounts

the equilibrium inflation-adjusted rate is currently near zero. This rate should rise gradually as the headwinds fade over time. But until they do, monetary policy rates must be even lower than they otherwise would be to provide adequate accommodation for economic growth.

Fed Chair Janet Yellen last month said that “convincing evidence that longer-term inflation expectations have moved lower would be a concern because declines in consumer and business expectations about inflation could put downward pressure on actual inflation, making the attainment of our 2 percent inflation goal more difficult.”