Inflation Expectations Are Near Multi-Year Lows by Eric Bush, CFA, Gavekal Capital Blog

With all eyes on the Federal Reserve this week, inflation-related data points are in investors’ crosshairs. Going through several reports and market expectations, it is certainly tough to find much evidence of inflation anywhere in the US economy. Last week we saw a couple of deflationary data releases with another negative year-over-year print for the PPI and falling import/export prices. Headline CPI continues to hover around 0% year-over-year, however, at least the core-CPI remains at 1.80% year-over-year. Our one-year CPI diffusion index remains near multi-year lows.

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If we turn our attention to market expectations, we again see inflation expectations at low levels that are rarely seen. 5-year TIPS implied breakeven inflation expectations are currently only 121 basis points and 10-year TIPS implied breakeven inflation expectations are just 159 basis points. These levels were briefly hit early this year but otherwise they are at the lowest levels since 2010. Same story for 30-year TIPS implied breakeven inflation expectations.

Finally, the preferred inflation measure during the Ben Bernanke led Fed has been at or below 2% for the past month. The five-year, five-year forward breakeven inflation rate currently sits at just 1.97%. 2% was a key level under the previous Fed regime as quantitative easing programs were started, or rumored to start, after inflation expectations hit this level. However, it is clear the Fed under Dr. Yellen does not put as much weight on this metric as the five-year, five-year forward breakeven inflation rate has bounced around 2% for almost the entirety of 2015.