Treasury Market’s Inflation Outlook Dips From Four-Year High

The Treasury’s market’s implied inflation forecast last week reached the highest level since 2014, reflecting growing concern that pricing pressure is heating up. But the reflation trade has cooled this week, providing support for some analysts who argue that inflation fears are exaggerated. A reality check is due to arrive in today’s January update on the Consumer Price Index (CPI).

Judging by the latest inflation estimate, based on the difference between the nominal 10-year rate less its inflation-indexed counterpart, the crowd’s outlook has moderated in recent days. This spread dipped to 2.05% yesterday (Feb. 13), according to Treasury.gov data – down from last week’s 2.14%, the highest since Sep. 2014. A similar U-turn applies to the implied outlook via 5-year Treasuries.

Meantime, economists are looking for a mildly softer inflation report in today’s CPI data. Econoday.com’s consensus forecast sees the year-over-year change for the headline figure easing to 2.0% in January from 2.1% at last year’s close. The annual pace of core CPI, which excludes energy and food, is also on track to dip, cooling to 1.7% from 1.8% and remaining modestly below the Fed’s 2.0% target.

George Goncalves, head of fixed-income strategy at Nomura, says that most forecasters are looking for minimal changes. “There’s no real outlier [in the projections] that suggests we’re going to see a break one way or the other.”

Michael Arone, chief investment strategist at State Street Global Advisors, thinks the recent concern that inflation is heating up is overblown. “Investors have gotten a bit ahead of themselves regarding inflation,” he advises. “Some of these inflation figures will come back down.”

Perhaps, although hedge funds are reportedly making hefty bets that Treasury yields will continue to rise, based on short positions in Treasury futures. Bloomberg reports that short bets for 10-year futures jumped to a record 939,351 contracts, according to Commodity Futures Trading Commission data through Feb. 6.