Yesterday in a scheduled Question and Answer session, Federal Reserve Chief Benjamin Bernanke dropped a number of dovish signals implying that the Federal Reserve’s unprecedented programs attempting to maintain financial stability will likely continue. The Fed is also wary of signs of weakness, and willing to keep the programs going longer than originally planned if employment is weak or inflation is lower than targeted (2%).
The most interesting comment may have been in a question about the QE, Quantitative Easing Program (wherein the Fed makes open market purchases of Treasuries, Bank Debt and Mortgage Backed Securities). The Fed had said in the past that unemployment rates of 6.5% (currently 7.6%) would trigger a ‘taper’ or an ‘easement’. Yesterday, Chairmen Bernanke hedged a little – saying that the 6.5% number was a “threshold, not a trigger”.
The Market Reaction to Bernanke’s Comments
Nice plunge, eh?
As I type this, mortgage rates are pretty volatile, and actually seem to be up a bit – I’ll take another look at the end of the day. Suffice to say the reaction is related to the comments yesterday – the dovish tone juiced stock markets a bit.
The downside? Every time it seems the punch bowl is getting close to being removed, someone fills it back up. This is the dynamic to watch over the next few years – in a strengthening economy, rates will eventually need to rise, and QE programs will eventually need to end. Thresholds, not triggers!
Here on Don’t Quit Your Day Job, we’ve shown you many times how to get a read on market inflation expectations. The quickest way is to subtract real yields from treasury yields for same maturity instruments. (Say, 10 year treasuries and 10 year TIPS). This introduces a bit of error – but since TIPS offer a yield plus an adjustment for CPI, the expectation is that, on average, the difference between the two is what traders expect inflation to be.
Today, however, we’ll concentrate on the Cleveland Fed, who publishes a series using inflation futures – and brags that their numbers are .25-.5 percentage points better on inflation expectations than the crude method we just shared. Today, let’s take them at their word and peer into the inflation crystal ball:
How to read that chart: the percentage on the left would be ‘per year’. So, over the next year, the market expects 1.34% inflation, and the market expects annualized 2.00% inflation over the next 30, as of June 1st.
We will certainly monitor both the Cleveland Fed and the crude method (hey, the resolution is higher – daily!), but you can plainly see the market isn’t pricing in tons of inflation in the next generation or so. Does that mean we won’t have any? Of course not… but it will plainly be unexpected if we do.
Where’s the Inflation!?
Yes – one reading of a Central Bank buying tons of safe assets and money stocks increasing wildly would be “oh, it’s going to be rough, see you later currency!”. Of course, the ‘amount’ of money (by any measure) isn’t the only important contributor to inflation. Velocity, or the number of times a new dollar is spent, is also important. Consider – if we printed a few trillion dollars, then burned them… how would inflation react?
Well, that’s pretty much what’s happening – M2 is increasing, but most of that new money is, uhh, burnt – by being held in reserve almost immediately. Luckily for you, we already wrote this article – if you would like a better explanation of why inflation (and expectations are so low), please read our article on the subject.
What’s your prediction for inflation over the next few years?