Markets' "mission accomplished" message on inflation
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As we await new inflation data and a Federal Reserve decision next week, there's an important backdrop emerging from the markets. Bond prices imply that the Fed's war on inflation is, in effect, won.
Why it matters: This backdrop makes it easier for the Fed to pause its rate hikes next week, as it has telegraphed it may, regardless of what the backward-looking May Consumer Price Index data due out Tuesday says.
By the numbers: The five-year breakeven rate — the gap between rates on five-year Treasury notes and comparable inflation-protected bonds — was 2.14% Thursday. That implies that the CPI will rise by that much each year over the next half-decade.
- Because the CPI runs a few ticks higher than the PCE price index the Fed targets, those breakeven numbers are entirely consistent with the central bank's 2% inflation target.
- By contrast, last spring, the five-year breakeven reached as high as 3.56%, a more alarming number that implied inflation was getting out of control — which surely contributed to the Fed's aggressive interest rate hikes last year.
Between the lines: Bond investors are pricing in enough of a growth slowdown that inflation will recede even without the Fed raising rates more. In that sense, they have a more benign outlook than ordinary Americans.
- The New York Fed's most recent survey of consumer expectations, for example, showed American households see inflation coming in at 2.9% annually over the coming five years.
Yes, but: Bond investors are hardly perfectly prescient. Breakeven rates didn't give any early warning of the outburst of inflation in the spring of 2021, for example. Market prices, just like any forecast, can be wrong.
- And from the Fed's perspective, the fact that ordinary citizens still expect inflation well above the 2% target in the coming years could be alarming in its own right.
