Inflation Is No Mystery to the Bond Market

The Federal Reserve and other central banks have been on a quest since 2012 to get inflation back up to levels they deem appropriate for a stable, growing economy. There have been many setbacks along the way, leaving central bankers stumped, with Fed Chair Janet Yellen saying the slowdown in inflation has been a "mystery." But their crusade may now be looking a bit less quixotic, judging by recent moves in the bond market.

Although inflation looks sluggish, there's evidence that pressures are building beneath the surface. This is can be seen in energy prices, general consumer prices in China and the U.K, and even in the New York Federal Reserve's Underlying Inflation Gauge, which has risen to 2.7 percent, its highest reading since 2007. The UIG incorporates dozens of additional variables outside of prices, including the unemployment rate, stock prices, bond yields and purchasing managers’ indexes, according to Bloomberg News.

At her press conference last week, Yellen dismissed the importance of trend inflation as measured by the UIG because the overall “inflation miss” remains unexplained. More than 25 percent of the components that make up the Consumer Price Index are in a protracted deflationary trend. But the U.S. economy may soon see a period of reflation simply because the prolonged bout of inflation "misses" could lead to more instances where the data registers higher readings as it's being measured against a lower base.