Treasury Inflation Forecasts Resume Slide Ahead Of Fed Meeting

A worrisome decline in the Treasury market’s implied inflation forecasts that began last October appeared to stabilize in the new year. But over the last week the downside bias has returned, raising questions about monetary policy ahead of tomorrow’s Federal Reserve’s policy meeting (Jan. 30), which will unveil new forecasts, a possible but unlikely change in interest rates and a press conference by Fed Chairman Jerome Powell.

The latest dip in Treasury inflation estimates is slight, but the so-far mild downturn of late follows several months of persistently lower projections and so it’s fair to say that the market’s outlook for pricing pressure remains substantially discounted compared with prevailing conditions as recently as three months ago. For example, the implied inflation forecast via the yield on the nominal 5-year Note less its inflation-indexed counterpart fell from nearly 2.1% in early October to just below 1.5% at the start of 2019.

As the new year has unfolded, the inflation estimates rebounded, but it now appears that the bounce was temporary and the downward trend has resumed. The 5-year forecast ended yesterday (Jan. 28) at 1.62%, close to the lowest level so far in 2019, based on daily data published by Treasury.gov.

Narayana Kocherlakota, a former president of the Federal Reserve Bank of Minneapolis, advises that “the Fed has been falling short — arguably well short — of both its inflation and employment mandates for a long time… With a potential slowdown coming in both US inflation and global growth, that means thinking about lowering interest rates rather than increasing them.”

A cut isn’t expected for tomorrow’s policy announcement. Fed funds futures are pricing in a virtual certainty that the Fed will leave its target rate unchanged at the current 2.25%-to-2.50% range, according to CME data. For the rest of the year, in fact, the futures market is expecting no change in the policy rate.

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