Some economists, including former Treasury Secretary Lawrence Summers, have argued that the next imminent injection of fiscal stimulus in the US will generate destabilizing inflationary pressures. But investors are not convinced.
The US equilibrium curve, which follows investors’ forecasts for inflation, has turned upside down, with short-term rates eclipsing long-term rates.
Previously, this happened in a sustained manner in 2008, during the global financial crisis. The two-year equilibrium rate, which is derived from inflation-protected US government bonds, now hovers at 2.7 percent, while the five-year indicator has recently reached 2.5 percent. The 10-year rate was slightly behind, at 2.3 percent.
This suggests that even despite the $ 1.9 trillion run of fiscal stimulus recently passed by Congress, investors expect any increase in inflation to decline rapidly.
“The equilibrium market is taking some risk that the Federal Reserve will be able to engender inflation to exceed its target in the short term,” said Tiffany Wilding, US economist at Pimco. “[But] there is very little risk of the kind of 1970s style outcome that some economists and market participants have alluded to. “
Market measures of inflation expectations, which are closely observed by monetary policy makers, have accelerated since the beginning of the year, with investors preparing for a more robust economic recovery after the Biden government’s relief program was approved.
While legislators and market participants are aligned that the coming months will bring about a rapid recovery in consumer price increases, opinions differ strongly about the durability of the change.
Jay Powell, president of the Federal Reserve, joined Janet Yellen, secretary of the Treasury, in minimizing concerns.
Powell recently argued that any jump in inflation would be “neither large nor sustained” and stressed that the economy is still a long way from the US central bank’s target of an average inflation of 2%. His favorite indicator, the basic price index for spending on personal consumption, is currently at 1.5%.
Gregory Daco, chief economist at Oxford Economics, is also of the opinion that inflationary pressures will increase this year, before easing.
“The most likely result is that after the peak of spring, inflation will drop, staying above 2% for longer than at any time in the past decade,” he said. “By long-term historical standards, inflation is still expected to remain relatively low and far from an out-of-control spiral.”
Even economists at Morgan Stanley – who pointed to an economic expansion of 7.3% above consensus this year and see sustained upward pressure on health care costs, house prices and some goods – recognize that inflation more broadly will be “transient”.
They predict that the PCE core will peak at 2.6 percent on an annual basis in April or May, before settling at around 2.3 percent later this year and throughout 2022.
Despite the temporary nature of these expected consumer price increases, the prospect of higher inflation and the Fed potentially moving forward at the time of its interest rate adjustments hit the $ 21 trillion market for US government debt strongly.
Trading conditions worsened last month as prices plunged and yields rose sharply. The 10-year note is now traded just before its biggest one-year high, at 1.53%, and strategists believe it is rising from here.
Jonathan Cohn of Credit Suisse now expects yields on the benchmark to rise to 1.9 percent by the end of the year, initially forecasting 1.6 percent. Goldman Sachs, Société Générale and TD Securities have also done similar reviews recently.