Tuesday, June 5, 2012

More on forward inflation expectations


Contrary to a recent post on Zero Hedge which notes that 5-yr, 5-yr forward inflation expectations according to Bloomberg's calculations have turned negative for the first time ever, I have updated my chart using Bloomberg's calculations of this variable (USGG5Y5Y Index, for those interested). Rather than falling to unprecedented lows, forward inflation expectations have now risen to their highest level since last August. My own calculations of this rate confirm Bloomberg's numbers, so I'm at a loss as to how ZH got the story backwards.

In any event, as I noted in a previous post, it is very interesting that forward inflation expectations are rising at a time when 10-yr Treasury yields have plunged. Moreover, it's very interesting that this has happened while gold has fallen, commodities have fallen, and the dollar has risen. It suggests that the driving force behind collapsing Treasury yields (and this includes the sovereign debt of the UK, Germany, and Japan as well) is a budding global panic over the likelihood of a global recession, accompanied by fears that this will all end with currency debasement (particularly of the Greek variety) and thus higher inflation. Investors apparently have an insatiable appetite for risk-free, yield-bearing assets, because they fear that everything else will be negative, while at the same time reasoning that eventually (some years in the future) governments will resort to even more monetary stimulus that will reignite inflation. It's a curious state of affairs, to say the least.


Jon Hilsenrath's story that broke late today has contributed to the rising inflation fears today, since he reports that the Fed is once again considering another round of easing. I'm still having difficulty understanding how more Fed easing could solve the problem of insolvent PIIGS, and I note in this regard that 2-yr Eurozone swap spreads are not signaling any sudden or acute shortage of liquidity. Furthermore, it seems to me that another round of QE would only exacerbate what appears to be an acute shortage of high-quality sovereign debt (e.g., Treasury notes and bonds, plus the bonds of the UK, German, and Japanese governments, all of which are trading at extremely low yields).

What this suggests, of course, is that monetary policy easing is the wrong response to the problem at hand. We don't have a shortage of liquidity, we have a failure of policymakers to understand that in order to improve the health of the world economy, we need to shrink Big Government just about everywhere. More liquidity injections may be necessary to keep banks functioning and markets liquid, but for now they can't fix the underlying problem which is more spending than private sectors can afford to bear.

On the bright side, Scott Walker's solid victory in today's Wisconsin election is one more marker on the long road to smaller government, and that's good news.

14 comments:

Dr William J McKibbin said...

The Walker victory in Wisconsin signals wider austerities to come -- that's good news for accredited investors with means...

Squire said...

I was going to point out the Zero Hedge 5 yr 5 yr article. I am glad to see you peruse so widely but I am not surprised. ZH is valuable but everything there needs to be confirmed. It helps me with the market mood for short term trading.

The Fed has a psychological need to be revered and they don’t want to look like the bad guys not helping the economy. More QE could backfire. You actually point out distortions and imbalances can be made in the dollar, government bonds, gold, and liquidity itself.

If we use the term austerity to mean live within our means, then we have to use the opposite word, profligacy, meaning living above our means. (I sound like a Sunday school teacher). Someday congress may do its job and reduce crony government. I will take leadership.

Accredited investors might do well to look at countries with low debt to GDP.

Jake said...

ZH definitely made an error. It looks like what they posted is the 5 year / 5 year forward real yield of TIPS, which turned negative for the first time ever.

Unknown said...

Effective federal funds rate has been edging up recently too. Yesterday it reached 0.17%, which is the highest since February 7 of last year.

Scott Grannis said...

Real yields on most TIPS have been negative for a long time, particularly for 5yrs.

John Short said...

Multi decade top in bonds is forming as we speak

Squire said...

San Diego passed 401k plans for new public hires. If it is a matching plan, the city will be right back where they started in a matter of years.

San Jose's plan pension reform was less aggressive. It had to be. The firement particularly, have massive political clout. This reform only breaks the ice.

Wealthy San Mateo County passed a tax on car rental cos. but failed a tax on parking lots and hotels. Go figure. Local parcel rates all passed proving that you never own your home you only rent it from the county.

Steve K said...

If Bernanke is considering a 3rd round of QE, then it's time for him to go( past time!)

I think the rally in the market today shows that investors approve on the Wisconsin results.

Joe said...

Thanks for debunking this and for your thoughtful comments. Zero Hedge should actually be called Zero Knowledge.

Donny Baseball said...

So, a hypothetical 5yr treasury sold 5 years from now ought to yield, what rationally? 3.5%, 4%, 4.75%??? But billions is being locked up at 1.7%.

Does anybody realize how much $ is going to be lost if the fear premium comes out of Treasuries?

William said...

Squire said...
"San Diego passed 401k plans for new public hires. If it is a matching plan, the city will be right back where they started in a matter of years...

The reasons corporations switched to 401ks is that it cut their retirement funding cost more than in half. Prior to 401ks, corporation typically paid 6% of employees salaries to fund their plans. With 401ks, they match only up to 3%.

But the real beauty of the 401k for corporations, including non-profits, is that only 1/3 of employees fully fund their 3% contribution. And about 20% don't fund their 401k at all. Net-net corporations are paying around 2% to fund employee retirement instead of the previous 6%.

So it will be a huge saving for San Diego.

Jake said...

"Real yields on most TIPS have been negative for a long time, particularly for 5yrs."

Correct, but this is the first time TIPS have been negative 5yrs/5yrs forward.

John said...

"What this suggests, of course, is that monetary policy easing is the wrong response to the problem at hand. We don't have a shortage of liquidity, we have a failure of policymakers to understand that in order to improve the health of the world economy, we need to shrink Big Government just about everywhere."

No, the problem's not Big Government, it's Bad Goverment. The problem is government that parasitizes its society instead of steering investments for the good of the nation.

Germany's government takes a leading role in making it an export-based economy. They educate their people and export higher-end items.

Furthermore, we need to increase demand for higher-end goods and services, not just gasoline, Cheerios, and toilet paper. One can not do that and simultaneously pursue policies promoting lower labor costs.

"if you don't pay the people enough money, they can't buy the cars." Henry Ford.

Benjamin said...

Inflation is dead. See Japan for insights. The Fed is fighting the last war. The 1970s died with my hairline.