Carpe Diem

Bonus chart of the day: Expected inflation from the bond market using the 10-year Treasury-TIPS spread = 2.23%

spreadThe monthly 10-year Breakeven Inflation Rate over the last ten years is displayed above and represents a market-based measure of expected inflation derived from the spread between 10-Year Treasury Constant Maturity Securities and 10-Year Treasury Inflation-Indexed Constant Maturity Securities as calculated and reported by the St. Louis Federal Reserve. The latest value from the Treasury spread in June implies that bond market participants expect inflation to average 2.23% annually over the next 10 years. In other words, the current bond market-determined measure of expected inflation, based on thousands of bond market participants who are putting millions of dollars at stake, suggests that inflation will remain low and stable over the next ten years at less than 2.50%. More market-based evidence that there are currently no inflationary pressures building in the US economy, even over a ten-year horizon.

See Jimmy P’s related post about inflation (“Why Amity Shlaes is Dead Wrong About Inflation”) here and my recent post (“More on Why Amity Shlaes is Dead Wrong About Inflation”) here.

Update: Here’s a related chart below of the “Expected Inflation Yield Curve” from 2015 to 2044, based on the Cleveland Fed’s estimates of inflation expectations for one-year periods out to a time horizon of 30 years. According to the Cleveland Fed:

The Cleveland Fed’s estimate of inflation expectations is based on a model that combines information from a number of sources to address the shortcomings of other, commonly used measures, such as the “break-even” rate derived from Treasury inflation protected securities (TIPS) or survey-based estimates.

The Federal Reserve Bank of Cleveland reports that its latest estimate of 10-year expected inflation is 1.83% (see chart below). In other words, the public currently expects the inflation rate to be less than 2 on average over the next decade.

clevelandMore empirical evidence that future inflation, out to a time horizon of 30 years, is expected to remain low and stable in a range between 1.5% and 2.25%.

39 thoughts on “Bonus chart of the day: Expected inflation from the bond market using the 10-year Treasury-TIPS spread = 2.23%

  1. a distinction worth pointing out:

    that does not necessarily provide a measure of expected inflation.

    it provides a measure of expected CPI.

    to the extent that one does not think CPI is a good inflation gauge, this index is not useful to measure inflation.

    personally, i would not use CPI to hedge inflation.

    CPI has become a cost of living index, not a measure of the price level.

    home prices are up 10% yoy.

    rents are up 5-6%.

    CPI “shelter” is up 2.9%.

    why would i accept even a pure play on that shelter number as a hedge for the cost of buying or renting a place to live?

      • BPP is a terrible inflation gauge that should be expected to dramatically under-report inflation.

        it uses non weighted prices, so a drop in the price of gum from $1 to 99c offsets the rise in price of a car from $50,000 to $50,500.

        it looks only at online prices and does not include services or most food.

        it ignores insurance, education, healthcare, and shelter.

        it massively overweights tech, the most deflationary sector of the economy.

        BPP mistakes using a lot of inputs for using meaningful inputs.

        if you live in a hard drive and eat iphones, it may be great, but it bears so little resemblance to an actual consumer basket as to be nearly meaningless and there is every reason to suspect it would dramatically under report inflation just by virtue of tech weighting and leaving out healthcare.

        i really do not see how BPP is terribly useful.

        • @morganovich
          > it uses non weighted prices [...] it ignores [...] healthcare

          it calculates health-care costs by weighting changes in the price of wages, energy and drugs.”

          “the BPP weights its index based on the BLS basket”

          > it massively overweights tech, the most deflationary sector of the economy.

          …Then we should expect it to drop in half every couple of years. It doesn’t seem to be doing that. It might, in fact, be exaggerating real inflation.

          • 1. so wages, energy, and a small amount of drug data that is mostly unavailable (it does not have access to prescription prices) seems like a good proxy for health care costs to you?

            it’s a completely made up number. further, it is assigned 7% weighting vs 18% in the actual us economy.

            2. and where is shelter in this mix?

            3. further, it ONLY looks at online prices, which are the most price competitive.

            it sees the price of bulk coffee, but not the price of the coffee you buy on the way to work.

            it sees a can of tuna, but not a tuna sandwich near your office.

            thus, it misses the part of the economy that has the most inflation because it has fewer substitutes and higher cost of switching.

            the same is true of the service sector.

            there is simply no way BPP could be exaggerating inflation.

            it likely runs low by 2-3 points.

            it has been tuned to look like cpi but is is neither capable of being nor designed to be a real consumer price measure.

            with housing up 10 and rent up 5, how does one average that to get to 2.9%

            you can’t.

            they use owner equivalent rent to mask this and pretend that because some people do not move, the price is lower.

            but that is not a market price nor a price level.

            would you say that because only 10% of people buy a new car a price hike in cars from $20k to 22k is only 2% and try to pass that off as a price level?

            price level is what you face if you go buy somehting. the fact that you might not buy it does not change that. the market price is the market price.

            CPI was shifted to be a COLA index, not a measure of price level.

            it’s not an inflation measure.

            if it were, shelter would read more like +7% which, by itself, would add a solid point to CPI.

            weight healthcare properly and you likely pick up another 50bp.

            include that fact that switching from rib eye to flank steak may reduce price, it also ought to have an offsetting quality adjustment, and now CPI starts to look like it might be only around 50% of the actual price level change.

          • @morganovich
            > it also ought to have an offsetting quality adjustment

            IIRC, the fact that it doesn’t is the reason Thomas Sowell says it exaggerates real inflation.

            2. Artifact of hyper-regulation/crony-capitalism in the real-estate industry. Liberalize real estate and homes might be sold on Amazon, where their prices could be captured by the BPP.

          • “IIRC, the fact that it doesn’t is the reason Thomas Sowell says it exaggerates real inflation.”

            i think you are misunderstanding my point.

            let me see if an example will help.

            if, for example, you like to eat ribeye steak and its price rises, the BLS will assume that you shift your consumption pattern toward, say, flank steak.

            this is called geometric weighting. there are several problems with doing this and all of them cause a systematic understatement of inflation.

            first off, the assumption is that price shifts are supply driven.

            that price rise is taken as exogenous.

            but there are multiple reasons price could rise. if the hike is because cattle herd are smaller, then yes, perhaps such weighting is realistic, but, if the price hike is caused by a change in demand, then it has the wrong sign. sometimes, prices rise because demand goes up and fall because demand goes down. we see this with meat/pasta depending on the current hipness of atkins/paleo. we saw it with pinot noir and merlot after the movie sideways. we see it every year during bbq season.

            the blanket geometric assumptions are getting a lot of their adjustments 180 degrees wrong.

            but that is not the only issue.

            what i was getting at before is this: substituting cheaper goods should have an offsetting quality adjustment.

            this makes the whole geometric weighting idea absurd.

            people value rib eye more than flank steak.

            how do we know? the market tells us. RE is twice the price of FS.

            so, if we swap out RE for FS, we are left with a basket of goods a consumer values less. this is the very definition of a quality decline. yet this is not taken into account.

            thus, the system often weights in the wrong direction (always toward cheap and toward lower inflation) and often gets that wrong. but even when it gets it right, it fails to account for the fact that the old basket was preferred to the new one.

            both tendencies will ALWAYS cause an understatement of inflation.

            one can try to argue that positive quality adjustments are not sufficient, but there is no empirical way to do so, it’s pure supposition, and, around things like houses year to year and food, there is little difference and among things like clothing and furniture, quality (unless you buy very high end) has plummeted. one could argue the same thing about food that is now truck ripened, lower nutrition, tastes worse, and is full of hormones, steroids, and antibiotics unless you pay a fair bit more.

            beef in 1940 is like organic beef today.

            so, it’s not at all clear to me that the case for quality adjustments being too low is at all sound. some things have gotten better to be sure (cars, computers, phones, etc) but this is far from universally true.

            in many cases cheap and nearly disposable has replaced high quality stuff that lasts. i sure see it in clothing.

            2. i’m not sure how your point about home sales being regulated is germane regardless of whether or not it is true. it’s a big cost. it’s not in the BPP. their healthcare estimate and weighting is a pure fiction. BPP pretty much HAS to read low. it measures all the most price competitive products and cannot read the most inflationary.

          • @morganovich
            > people value rib eye more than flank steak. how do we know? the market tells us. RE is twice the price of FS.

            That works in the short run, but not the long run. Prices ultimately approach the cost of production, regardless of consumer valuation.

            > lower nutrition, tastes worse, and is full of hormones, steroids, and antibiotics [...] beef in 1940 is like organic beef today.

            Organic beef isn’t higher quality, and today’s commercial beef is higher quality than anything from 1940. Organic beef simply costs more to produce, which is why it costs more in the store. There’s some Fear, Uncertainty, and Doubt (especially when the buyer is buying for more than just herself, and therefore feels guilty about possibly trading quality for money), so organic captures some of the market, despite not providing anything more of real value to consumers. Is the CPI evil for not falling prey to FUD marketing?

  2. At the risk of being disagreeable, I find these predictions hard to believe. They seem like straight line estimates to me.

    I feel very uncomfortable about expecting no more than 0.2 percentage point gain inflation through 2034.

    Given that the economy is expanding and, presumably, will generally continue to do so over the next 20 years (of course, there will be other recessions, but I am talking the very very broad trend), that would mean that inflation would have to rise. Currently, inflation (as measured by the CPI) is well below its long-term average. I have a hard time believing it would remain so for 20 years.

    Are we in for 70′s style-inflation? Probably not. But benign inflation for 20 years seems optimistic, all things considered.

    • @Jon Murphy
      > I have a hard time believing it would remain so for 20 years.

      It just did remain so for 22 years straight. Why couldn’t this be the new normal?

      • TIPS or the CPI?

        If the CPI, you cannot accurately compare pre-2000 to post-2000 given a change in the methodology (they did not go back and revise).

        But even if we were to go back to 2002 (22 years ago), the average CPI inflation was 2.5%, still above the current level and above what the yield curve suggests.

        Is it possible this is the new normal? Sure. I just don’t see much evidence to suggest it is.

        I mean, a good part of why the inflation rate has been benign since the end of the recession is the international market. While the US has been fairly strong, Europe and the BRICs have been weak. Considering these economies are huge consumers of commodities, prices have been low keeping input costs down. There isn’t much reason for prices to rise in the near term, but if the whole world is running in 2015-2019, then I cannot, logically, think of a reason why inflation would remain low.

        But perhaps I am missing something. What has changed/is changing in the global economy that would keep inflation around 2%, even as the economies reaccelerate?

        • @Jon Murphy
          > What has changed

          The Federal Reserve has developed the ability to control inflation to such a degree that annual inflation hasn’t risen above 3.85% (cy) in 22 years, and only fell below 1.47% (cy) in one recession year. Throwing out the two outlier years, the 22-year range was 1.47% to 3.39%, and the Fed seems to be getting even better lately at keeping it close to 2%.

          > but if the whole world is running in 2015-2019

          …Then Bernanke will simply “taper” the QE.

          • Annual inflation (as measured by the CPI) was above 3.85% in the recession months, the middle part of 2006, and parts of the early 90′s.

            But again, as I mentioned, you cannot compare pre-2000 CPI to post-2000 CPI.

            Besides, not sure how much credit the Fed deserves vs globalization.

            Finally, Ben cannot taper QE for two main reasons: 1) He’s not in charge anymore and 2) QE is over in two months anyway. The Fed announced they’ll end QE in October.

            So, my question remains: what changed?

          • and the Fed seems to be getting even better lately at keeping it close to 2%.

            Despite their best efforts. Remember they’re been trying to get inflation above 2% and have been unable to. That simple fact makes me doubt your description of Fed prowess.

          • @Jon Murphy
            > months

            …Not relevant for investors. Why not pick days, hours, minutes, or seconds? Surely you could find at least one second in the last 22 years in which annualized inflation was over 100%. If prices rose in one given second merely 0.00000317% in comparison to the previous second, that would be equivalent to an annualized inflation of over 100%. Would that be relevant for investors? No.

            > what changed?

            It doesn’t need to be known. We know inflation can be controlled with unprecedented accuracy because of the 22-year track record from 1992-2013, inclusive, in comparison to any previous period.

            > you cannot compare pre-2000 CPI to post-2000 CPI.

            If you were to apply today’s methodology to pre-200 prices, it would make my point stronger, not weaker.

          • @Jon Murphy
            > they’re been trying to get inflation above 2% and have been unable to. That simple fact makes me doubt your description of Fed prowess.

            When “missing” a target, the distance to the goal matters. If the Fed’s goal were actually 20+% inflation, you might have a point — except that consistency matters more than general inflation levels, and the past 22 years has been a model of inflation consistency. You could argue it was just an accident, but the burden of proof would be on you.

          • Hittsquad:

            You said “annual inflation.” The numbers I am referring to are annual inflation, just for those months. So, for example, if annual inflation for April 2006 was 7% (it wasn’t, but let’s just say it was), that means inflation was 7% for the 12 months ending April 2006. I’m looking at a 12-month moving average to constantly monitor annual inflation.

            It doesn’t need to be known.

            It does for me. This whole “the Fed can control it” doesn’t suffice (or pass the smell test). As I said, they can’t even get it up a few bps despite their best efforts. How can you possibly say they can control it “with unprecedented accuracy?”

            Now, we know inflation is cyclical. It will typically rise for approximately 20-30 years before falling for approximately 20-30 years. We are nearing the end of a disinflationary cycle which began in the 80′s. Based upon the historic nature of inflation rates, it would seem the Fed has been more lucky than good over the past 22 years and we will likely see greater inflation in the coming years, especially as the global markets reaccelerate.

            Now, perhaps the Fed have become competent after 100 years, but given their inability to even get a few bps rise despite unprecedented activity and activism, it makes me very skeptical of their ability to control interest rates “with unprecedented accuracy”.

          • @Jon Murphy
            >>>> The Federal Reserve has developed the ability to control inflation to such a degree that annual inflation hasn’t risen above 3.85% (cy) in 22 years, and only fell below 1.47% (cy) in one recession year.
            > You said “annual inflation.”

            What did you think (cy) meant? Calendar Year.

            > How can you possibly say they can control it “with unprecedented accuracy?”

            …By looking at this. In the first half of the 20th century, calendar-year inflation rates ranged from 17.80% to -10.85%, with many swings back and forth.

            > Now, perhaps the Fed have become competent after 100 years, but given their inability to even get a few bps rise

            Setting a difficult target for oneself makes one incompetent?

          • Oh, I didn’t know what cy meant.

            Regardless, I think my point still stands.

            …By looking at this. In the first half of the 20th century, calendar-year inflation rates ranged from 17.80% to -10.85%, with many swings back and forth.

            Ok, but back to my point about inflation being cyclical. Is the Fed getting good or just getting lucky?

            Setting a difficult target for oneself makes one incompetent?

            Not at all. But being unable to even get it going in the general direction you want despite your best efforts suggests one’s control is limited.

            Say I want to lose 20 lbs by year-end. That sure is a tough goal. If I only lose 5 lbs, I’d say it was a tough goal but my methods were working, albeit slower than I wanted. Conversely, if I wanted to lose 20 lbs, and my weight stayed the same or rose, then I’d have to question the methods.

            That’s what I’m going here. The Fed has been desperately trying to get inflation up for years now and inflation has remained flat-to-disinflationary.

            So, is the Fed suddenly incompetent after 20 years of competency? Has something changed that, for some reason, is reducing the effectiveness of the unprecedented monetary policy (and, if that thing changes back, could there be a sudden jump in inflation?)? Has the Fed just been lucky enough to be at the right place at the right time?

          • @Jon Murphy
            > But being unable to even get it going in the general direction you want

            These are the last 3 months:

            April: 1.95 %
            May: 2.13 %
            June: 2.07 %

            This is the average of the past 12 months: 1.68%
            This was 2013: 1.47 %

            That isn’t getting going in the general direction the Fed wants? Compare that degree of control with the degree of inflation/deflation bipolar insanity that ruled the world for 10,000 years until 1992.

            > inflation has remained flat-to-disinflationary.

            The last month there was deflation was October 2009, almost 5 years ago (and it was only -0.18% annualized). If the Fed is prioritizing the avoidance of deflation, it seems to be achieving that (with the exception of a certain 8 straight months in 2009), without even a single month since the recession exceeding 3.87% annualized. Again, the degree of control we’re witnessing is unprecedented (though the 12-year period from 1956-1967 inclusive comes close).

            > Oh, I didn’t know what cy meant.

            I should have clarified when I first used the abbreviation. Sorry.

          • Why focus only on the past few months?

            If you look at the end of the recession, annual inflation has averaged 1.8%, with little deviation from that (except for 2011). The Fed has constantly said they want higher and higher inflation. We have been in an disinflationary trend for the past two and a half years.

            You’re not giving me much to believe you. Like I said, there is a lot of reason to question whether the Fed is good or lucky. All you can tell me, right now, is that they are lucky. And that makes me even more worried about my inflation expectations going forward: if we just assume straight-line projections, then even a little bit of inflation (say, 3% over a period of time) can cause major problems.

          • Hit

            All the while Jon Murphy is gently offering you a view of the forest, you seem determined to keep examining the bark on that one tree. I see he has given up on you.

          • I haven’t given up, Ron.

            I’m just begging (begging!) him to give me something. Show me that the current decline will buck the historical trend and keep declining. Show me the change in methodology that the Fed has done that made them more competent. I have an analytic mind. I need to see cause and effect. Arguing causation from correlation just doesn’t do it for me.

            Give me something!

          • @Jon Murphy
            > All you can tell me, right now, is that they are lucky.

            No. “Lucky” was your claim. You still have yet to support it with evidence.

            If the odds of the Fed being “lucky” in any given year were 50%, the odds of the Fed have been “lucky” for the past 23 years would be 0.5^23 = 0.00000011920928955078125

            There’s a 99.99999% chance the Fed wasn’t “lucky”.

            > even a little bit of inflation (say, 3% over a period of time) can cause major problems.

            The burden of proof is, once again, on you.

          • If the odds of the Fed being “lucky” in any given year were 50%, the odds of the Fed have been “lucky” for the past 23 years would be 0.5^23 = 0.00000011920928955078125

            Stranger things have happened. What do you think the odds are of life? But I’m not arguing Hari Seldon psychohistory here.

            The burden of proof is, once again, on you.

            Why is the burden of proof on me? All I’ve done is point out inflation is below average and, given the Law of Averages, would have to rise.

            You’re the one saying the Fed has gotten better and this is the new normal. I’m just asking how is the Fed better than, say 30 years ago. Why isn;t the Fed lucky?

            Give me something, anything!

          • hit-

            the fed is no better at controlling inflation.

            mostly, it was defined out of existence. using the CPI fro the 80′s, it currently reads more like 4-5% and has been in the double digits several times since the late 90′s.

            the old method was trending up all through the 90′s in contrast to the new one which trended down. the real world acted like the 60′s and 70′s, but the new, post 1992 definition renamed what would have been called high and rising inflation low and dropping inflation.

            the 2 series are not comparable. for any given set of objective inputs, the new methodology reads much lower. we can argue about which method is better, but not the effect of the change. that is certain. so, by your logic, given that these same facts from the last decade would get us numbers from 4-11% inflation, the fed had learned nothing since burns except how to define inflation away.

            QE and ZIRP have been successful in staying relatively sterile because they have cased asset inflation (stocks, bonds, real estate, collectibles) and hamstrung the economy.

            if you have not read it, may i recommend this:

            http://www.bis.org/publ/arpdf/ar2014e.htm

            i think the BIS nailed this.

            “Currently, monetary easing happens too quickly during busts, and governments need to find ways to make the policy counteract the financial cycle so it does not exacerbate existing problems or add new ones (such as expansionary monetary policy in recessions, encouraging higher debt levels). Perhaps due to central bank expansion, the real global economic recovery has been weak, with growth driven by emerging-market economies. While growth is up, it is not on pace to fully make up lost ground. Much of the expansion has been financed by debt, as debt-to-GDP ratios in advanced economies have grown higher.”

            “One of the consequences of this accommodative monetary policy has been an exuberant financial market and a weak real recovery, as monetary policy has failed to encourage investment. Central banks should wind down expansionary monetary policy without delay.”

            so, the fed, who sought more inflation and better growth, got the opposite: punk growth and asset inflation, but no CPI (new) though ti would have gotten it using the old one, esp in the mid 2000′s which would have read double digits.

            they have been keystone cops incompetent for the last 18 years or so.

            they keep getting the opposite of what they shoot for.

            i find notions that they have “gotten good at controlling inflation” to be unsupportable. they have not. they are just so bad at stimulating growth that that they wound up keeping inflation from exploding (though they have set of some dangerous new debt bubbles and arguably one in equities as well) but again, that’s also only because they defined it away.

            using the same methodology for both, the 2000′s looked quite a bit like the 60′s and 70′s in terms of inflation.

            the only reason you are seeing such “control” is that inflation has been defined out of existence.

            7% rises in the cost of shelter are now called 2.9%, etc.

          • Jon

            You’re the one saying the Fed has gotten better and this is the new normal. I’m just asking how is the Fed better than, say 30 years ago.

            Well, obviously the Fed is better: as we can see inflation is lower, and of course inflation is lower because the Fed is better.

            QED

            Is that the “something” you were hoping for? :)

    • “I feel very uncomfortable about expecting no more than 0.2 percentage point gain inflation through 2034.”

      Jon, did you mean 0.2 percentage gain for inflation per month or year?

  3. The measure of people’s expectations of inflation is just that, expectations. Much of people’s expectations in the market is based on their most recent experience. Rates have been low for the last few years, people on average expect them to stay low going forward. Inflation has been low as well, peope expect the same to continue. Markets have been doing very well, people expect them to continue and P/E expansion occurs.

    What would be usefull is if Dr. Perry can show that there is a relationship between people’s expectations of inflation in the past and what inflation actually was after those expectations. Is there any predictive value in this expected inflation measure based on past experience?

    • Yeah, I was going to say the same. Nobody has ever and will ever be able to “predict” inflation. As such, this market data is all just calculated guesses, that could be proven drastically wrong depending on whether there’s another tech boom or if the Fed doesn’t tighten up again.

      The whole notion of “inflation” is screwy, an artifact of the technocratic Progressive era, when they thought they could measure price changes in the entire economy and divine something meaningful from the data, ignoring the variability and massive subjective component to price. Unless one is printing money en masse like Zimbabwe, which has not happened here despite all claims to the contrary, I question the utility of the entire concept of “inflation.”

  4. A broader measure of inflation, the PCE deflator, is even lower than the CPI. The Fed goes by the PCE.
    Globally, inflation and interest rates have been falling for 30 years. In every year, pencil-dick inflation-hysterics have shrilly screeched about inflation.
    They are still squawking!

    • As I mentioned before, inflation is cyclical. It goes up, it goes down. This is not usual.

      Beware of straight-line projections. Many people have been destroyed that way (Malthus, Ehrlich, Krugman…)

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