The More Yellen Talks Up Inflation, the Less Traders Believe Her

When Will Monetary Policy Distortion End?
  • Market inflation expectations fall to lowest since 2009
  • Yellen reiterates view inflation will rise gradually

The bond market isn’t buying what Federal Reserve Chair Janet Yellen is selling on inflation.

While she reiterated last week that the Fed expects inflation to gradually rise back near 2 percent, long- and short-term market forecasts for price gains have plunged to their lowest levels since 2009. That’s even though oil prices remain about 16 percent above their lows from late August. The difference between yields on inflation-linked Treasuries and those on nominal securities plunged by the most in four years Monday.

“We’ve had so many years of accommodative policy, I think the market is losing faith in the Fed,” said Priya Misra, the head of global interest-rate strategy in New York at TD Securities, one of the 22 primary dealers that trade with the central bank. “You’re not really seeing the impact of policy end up in inflation.”

Falling energy prices have contributed to keeping inflation low, a trend that should be transitory, according to Yellen. But she cited another force behind cooling inflation -- the stronger dollar, which depresses import prices, as shown in a chart accompanying her speech.

Monetary stimulus by international central banks props up the greenback, complicating Fed policy makers’ efforts to boost inflation.

"They’re utilizing a monetary policy that’s not designed to influence what’s going on right now," said Jack McIntyre, a portfolio manager with Brandywine Global Investment Management, which oversees $67 billion in Philadelphia.

In the press conference following the Fed’s Sept. 17 decision to hold its benchmark rate near zero, where it’s been since 2008, "she talked a lot about global, external influences, and that’s going to take some time to resolve itself," McIntyre said.

‘Well Anchored’

It isn’t clear how much weight Fed officials assign to market forecasts for inflation.

Yellen said Thursday that declining demand for inflation compensation may indicate that traders have very low inflation forecasts.

"Although the evidence, on balance, suggests that inflation expectations are well anchored at present, policy makers would be unwise to take this situation for granted," she said in her remarks.

Traders’ bets following the Fed decision indicate they see interest rates only rising to 0.68 percent by the end of 2016, about half as high as the median forecast from Fed policy makers. The gap is the widest since Yellen started her term in early 2014.

Because of that gulf, if the Fed does raise rates, short-term Treasuries could be at risk of losses, according to Aleksandar Kocic, an interest-rate derivatives analyst with Deutsche Bank AG in New York.

"By making it more complacent, you have more and more people in one position, which means that every unwind is going to potentially be explosive," said Kocic. “It always ends in tears."

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