US Treasury Market’s Inflation Forecast Slips To 4-Year Low

Ahead of today’s September report on US consumer inflation, the Treasury market’s implied inflation forecast via 5-year maturities quietly ticked down to 1.24% in Wednesday’s trading (based on daily data via The crowd’s estimate of future pricing pressure for 5-year Notes marks the lowest level since February 2016. Although market-based estimates of future inflation should be viewed cautiously, the latest dip is a reminder that a downside bias continues to prevail in this corner of economic expectations.

The market’s inflation outlook via 10-year Notes (calculated as the yield spread on the nominal security less its inflation-indexed counterpart) has also fallen lately, settling at 1.49% yesterday (Sep. 9), fractionally above Tuesday’s level. But the big picture on Mr. Market’s inflation outlook is unambiguous, namely: manage expectations down.

Federal Reserve Chairman said as much yesterday, commenting that low inflation is one of the “longer-term challenges” for US monetary policy. He recognized that not everyone agrees with this analysis. “You may be asking, ‘What’s wrong with low inflation and low interest rates?’” Rightly or wrongly, the Fed is prepared to act to combat what it sees as a disinflation threat.

Economists, however, aren’t looking for a smoking gun in today’s release on consumer prices for September (due at 8:30 eastern).’s consensus point forecast sees headline CPI edging up to a 1.8% annual change. Although that’s slightly below the Fed’s 2.0% inflation target, it’s not obvious in this data set that disinflation is a problem. Indeed, core CPI (a more reliable measure of inflation’s trend) has been running above the 2.0% target lately and is on track to hold at a 2.4% annual pace through September.

How should we square the divergent inflation profile for core CPI vs. the Treasury market’s outlook? One explanation: the global decline in bond yields (including the rising prevalence of negative rates in some countries) is driving foreign investors into relatively high-yielding Treasuries. In turn, that’s driving US government rates down, for reasons that are less about American disinflation vs. a desperate search for yield around the world and within the US.

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