AIT Is Increasingly Credible

The Fed recently forecast 2.4% PCE inflation for 2021. The TIPS markets are showing evidence that investors expect 2% PCE inflation over 30 years, and somewhat higher inflation over the next 5 years. This is all consistent with the Fed’s 2% AIT framework, as some make-up is required for the 2020 undershoot of 2% inflation. Mostly because of AIT, the economic recovery will likely be much faster than during 2009-19.

Note that TIPS are indexed to the CPI, which runs at least 25 basis points above the PCE that is being targeted at 2%. So TIPS spreads need to be adjusted downwards by at least 25 basis points to get a crude estimate of market PCE inflation forecasts. And finally, TIPS spreads are not a perfect indicator, as there may be a time-varying liquidity premium:

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