Inflation expectations approach pre-crisis range

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On the burning issue of inflationary pressures, Asha Banglore (Northern Trust) yesterday remarked as follows: “Inflation expectations as measured by the difference between yields of the nominal US 10-year Treasury note and the 10-year inflation protected security are now at levels seen prior to the onset of the financial crisis in August 2007. As of January 8, the difference between the nominal yield and yield on the inflation protected 10-year US Treasury securities was 245 bps. Inflation expectations have climbed 28 bps during the last 20 trading days.

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“The movements of inflation expectations will be watched closely in the near term.  The Fed’s ability to influence the course of economic growth will be prevented if inflation expectations become unhinged,” she said.

The minutes of the December 2009 FOMC meeting indicate that the staff did a special presentation on inflation and inflation expectations. The highlights of this discussion were reported as follows: “Evidence suggested that sizable shifts in the longer-run inflation expectations of households and firms had influenced the evolution of inflation over previous decades; in contrast, the anchoring of inflation expectations in recent years likely had damped somewhat the response of actual inflation to the recent economic downturn and to fluctuations in the prices of energy and other commodities. In discussing these issues, participants noted that they bear in mind the shocks hitting the economy and regularly monitor more than one measure of resource slack as they assess the outlook for economic activity and inflation. They also noted the importance of formulating monetary policy in ways that would work well across a range of possible economic structures rather than relying on any one analytical framework. Finally, they underscored the importance of keeping longer-run inflation expectations firmly anchored to help achieve the Federal Reserve’s dual mandate for maximum employment and price stability.”

Meanwile Peter Boockvar reported on The Big Picture blog as follows: “The 10 yr TIPS auction was good as the yield was about in line with expectations but the bid to cover at 2.65 is above the ‘09 average of 2.59 and the average over the past 2 yrs of 2.30. It’s the 2nd highest going back to 2000. Ahead of the auction, the implied inflation rate in the 10 yr TIPS was 2.45% which means if one believes inflation will run above that over the next 10 yrs on average then buy inflation protection and vice versa.”

“Bullish economic reports are most likely to lead to pressure on long-term interest rates and push inflation expectations into a new range. Having said that, a caveat is necessary, final demand in the US economy is significantly weak and it is unlikely to post robust growth until the final three months of the year. Therefore, it is reasonable to expect that inflation expectations will remain anchored in the months ahead,” concluded Bangalore.

Perhaps, but I am in no hurry to see my gold holdings protecting my portfolio against the biggest monetary reflation in human history.

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