[Reuters]–The US Treasury market is factoring in future inflation. This is because the US economy is recovering from the catastrophic business closure caused by the new coronavirus epidemic. Analysts say inflation expectations are likely to rise further as the Federal Reserve welcomes the move as inflationary pressures continue to be weak.
The break-even inflation rate (BEI) of 10-year US price-linked bonds (TIPS), which shows the outlook for the average annual inflation rate over the next 10 years in the United States, temporarily rose to 2.19%, the highest level since mid-2018. ..
BEI, which has a 10-year period, fell below 2% in profit-taking sales last month, but then started to rise again.
Traders are investing in the hope that the US economy, which suffered the worst post-WWII decline last year, will normalize in the second half of this year and prices will rise.
“Everything is hot right now,” said Guy Rubas, chief fixed income strategist at Janny Montgomery Scott, pointing out that manufacturing, services, labor and housing markets are all improving. “It’s been a while since we’ve seen so many factors lean towards rising inflation,” he said.
Inflation expectations are also boosted by the prospect of enacting a large-scale new corona additional measure bill. The U.S. Senate passed a budget resolution to implement President Biden’s $ 1.9 trillion additional economic measures bill on the 5th, and the Democratic Party will pass the bill within a few weeks without the approval of the Republican Party. It became possible.
Fed officials support rising inflation expectations. Last year, the Fed launched a new strategy that would leave the rising pressure on prices for longer than before and not raise rates during that time.
TIPS suggests that the year-on-year rate of increase in the consumer price index (CPI) will rise from 1.4% in December last year to over 2% in the future. However, in reality, the Fed’s focus on the consumer price index (PCE) has been 30-50 basis points (bp) lower than the CPI in the past. In other words, the rate of increase in the PCE price index is expected to fall short of the Fed’s target of 2%.
Michael Pond of Barclays (New York) said the CPI forecast by TIPS was “not particularly high compared to the 2% PCE outlook.”
It is not clear until the US economy normalizes whether inflation will rise, which is another factor that raises inflation expectations. “Whatever the outlook and current inflation rates, we don’t know if the reflation scenario will end up wrong until we have a firm grasp of the second half of this year,” Pound said.
In addition, if the year-on-year rate of increase in prices is excluded from the comparison target before March last year, the apparent growth will be very large, which is likely to accelerate inflation expectations in the short term.
However, if inflation does not actually rise, recent rising inflation expectations could turn into disappointment.
“The market will be in a tremendous feint,” said Robert Tip, chief investment strategist at PGIM, about the recent rise in inflation expectations.
Tip said BEI is likely to continue rising later this year, but will not exceed 2.50%. “Investors believe the U.S. economy will return to its booming 2018-19 state. What they have overlooked has been a consistent slowdown in population acceleration and slow growth over the last 40 years. That’s the point that has been spurred recently. “
TIPS BEI is also supported by the supply and demand of bonds. The US Treasury is increasing the issuance of regular government bonds to cover fiscal spending, but the pace of expansion of TIPS issuance is slower than that of regular government bonds.
Moreover, the Treasury is buying a large amount of TIPS. In the bond market, the liquidity of TIPS is smaller than that of ordinary government bonds, and price fluctuations are large.
“There is no doubt that the relative lack of liquidity in TIPS is one of the factors behind the expansion of BEI,” said Michael Lorizio of Manulife Investment Management.
However, lack of liquidity in TIPS may pose a risk if expectations for rising inflation recede towards the end of the year. “It’s clear that the lack of liquidity in TIPS will accelerate the reversal of the market if the market changes,” Lorizio said.
(Karen Brettell reporter Karen Pierog reporter)