In Bond-Market Irony, Inflation Is Lower Than When Fed Eased

  • Central bank may raise rates even as price gains trail target
  • Debt-buying helped generate jobs, while wage gains lag behind

Fed Decision-Day: Weighing the Impact

In September 2012, Fed policy makers found a bond-market measure predicting a 1.9 percent future inflation rate among the reasons to expand monetary stimulus by adding to their unprecedented bond-buying program.

The central bank ended its quantitative easing in late 2014 and this week may further curtail accommodation by raising interest rates, even as the same inflation gauge has slowed to 1.2 percent. The gap between yields on five-year Treasury Inflation Protected Securities and equivalent nominal debt, known as the break-even rate, is at almost its lowest level this year before the central bank’s policy statement Thursday.

Since establishing an inflation target of 2 percent in 2012, the Fed has never been farther from its goal, as measured by personal consumption expenditures. Other gauges of consumer prices including gasoline at the pump are mostly lower than they were when policy makers were adding stimulus.

“There really isn’t a good rationale for them to hike at all,” said Robert Tipp, chief investment strategist in Newark, New Jersey, for Prudential Financial’s fixed-income division, which oversees $533 billion in bonds. 

The Fed’s stimulus program was designed to bolster the economy by raising inflation to growth-oriented levels and helping to create jobs.

Fed accommodation peaked in 2013 with $85 billion in monthly bond purchases, consisting of $45 billion in Treasuries and $40 billion in mortgage bonds. Those purchases, which were gradually reduced through 2014 and ended in October, pushed the central bank’s balance sheet to a record $4.5 trillion, up from $900 billion in September 2008, before the nadir of the financial crisis.

Rate Case

The Fed has two mandates, stable prices and full employment, and a big part of the case for higher interest rates is built on the decline in unemployment to the lowest level since April 2008. At the same time, the higher wages needed to fuel faster consumer spending have yet to appear in economic data. 

Since the recession ended, wages have climbed an average of 2.1 percent annually, the weakest in any expansion since at least the 1960s, data compiled by Bloomberg show. That lack of wage growth has contributed to slower price gains, with the consumer price index rising 0.2 percent during the past 12 months, and helping to hold benchmark 10-year Treasury yields near historic lows. That yield was at 2.28 percent as of 9:44 a.m. in New York.

Goldman Sachs Group Inc. Chief Executive Officer Lloyd Blankfein said Wednesday that economic data don’t support the case for higher interest rates. Rather than firing the starter’s pistol for a rate increase, the Fed’s decision to stop bond purchases, as well as higher taxes, have acted as a brake on the economy and a form of tightening, Blankfein said at a breakfast in New York sponsored by the Wall Street Journal.

“It is very, very difficult to find any inflation anywhere in the world of any meaningful amount,” said Anne Richards, chief investment officer of Aberdeen Asset Management, which manages $483 billion. The Fed is unlikely to increase interest rates this year because its unconventional monetary policy has created “no inflation and a very anemic recovery.”

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