Bonds Show Inflation Outlook Falling to Lowest Level Since 2009

  • Gauges near levels not `seen outside of times of crisis'
  • Traders await speech by Fed Chair Yellen on Thursday

The bond market’s inflation outlook for the next 10 years touched the lowest since May 2009, raising questions about the Federal Reserve’s ability to increase interest rates this year.

The 10-year break-even rate, a bond-market measure derived from the yield difference between Treasuries and inflation-linked bonds, showed consumer prices rising at an average pace of 1.48 percent during the next 10 years, well below the Fed’s target of 2 percent. The inflation measure preferred by Fed officials last reached that level in April 2012.

“You’re getting close to levels you haven’t seen outside of times of crisis,” said Aaron Kohli, a fixed-income strategist at Bank of Montreal, one of 22 primary dealers that trade with the central bank. “The market is becoming a lot more pessimistic about the direction of inflation.”

The economy and the bond market have resisted policy makers’ efforts to stoke expectations for higher prices. Instead a slowdown in global growth has fueled a slump in commodities and led the Fed to mention risks posed to U.S. output by reduced growth rates overseas, particularly in China, in its most recent policy statement. 

Inflation Dynamics

Fed Chair Janet Yellen will deliver a speech on “Inflation Dynamics and Monetary Policy” at 5 p.m. in Amherst, Massachusetts. She said at a Sept. 17 press conference that the Federal Open Market Committee opted not to raise interest rates at its policy meeting last week in light of heightened uncertainties abroad and a lower expected path for inflation.

Policy makers forecast that personal consumption expenditures, the Fed’s preferred measure of prices, will likely to rise to 1.8 percent to 2 percent in 2017.

The difference between the market’s inflation forecast and the Fed’s outlook for rising costs means “to some extent, the Fed has to dismiss this, because if they believed that, they’d be at a much different part of their cycle,” Kohli said.

A Fed measure of five-year inflation expectations five years in the future is near the lowest since 1999, suggesting that bets for low inflation are embedded well beyond the impact of slumping oil prices, which have fallen by more than half in the past year.

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