A closely-watched bond market measure of inflation expectations on Monday hit its lowest level since the depths of the recession in 2009, a sign the Federal Reserve could end up delaying its long-expected interest rate hike in September.
The 10-year “breakeven” rate, the difference between the conventional 10-year Treasury security and special inflation-protected 10-year Treasury securities, fell below 1.5 percent Monday, matching the lowest it had been since mid-2009. The drop came amid a market rout that saw the 10-year Treasury dip as low as 1.92 percent Monday, the lowest it’s been since April.
The 10-year breakeven rate is interpreted by many analysts as an indication of market expectations for future inflation, and its decline could raise fears about the direction of the U.S. economy and tamp expectations for the Federal Reserve to tighten monetary policy.
Rapidly falling inflation expectations could signal concerns about the economy “cooling off,” with labor and other resources going underutilized, which would likely be seen as a reason not to raise rates.
The 10-year breakeven had risen as high as 1.94 percent earlier in the summer. But the latest inflation expectations suggested by the 10-year breakeven rate are well below the Federal Reserve’s target, which is for 2 percent inflation over the long-term.
Fed policy is one of the major questions facing investors at the moment. The central bank’s monetary policy committee is set to consider raising rates for the first time in nearly a decade at a highly-anticipated meeting in mid-September, and traders will be eagerly awaiting to see if the new inflation data gives the Fed reason to pause.
Still, Fed officials, including Chairwoman Janet Yellen, have cautioned against over-interpreting movements in inflation-protected securities relative to regular Treasury securities.
In recent statements, they have distinguished between signals based on the compensation investors are willing to pay for the inflation-protected securities and indications from survey-based measures of inflation expectations. Those surveys, such as the University of Michigan survey of consumers and the Federal Reserve Bank of Philadelphia survey of professional economists, have yet to show major movements in inflation expectations.
In its February monetary policy report, the Fed cited several reasons that movements in the 10-year breakeven rate and other bond market measures might reflect factors beside inflation expectations, and thus be less useful for understanding where the market expects inflation to go. Those factors include the fact that investors might demand a premium for taking on inflation risk or that demand for liquidity might also affect prices.
Although it’s difficult to disentangle those effects, some Fed officials have in the past cited 10-year breakevens as reason to be concerned about inflation expectations, meaning that the recent steep decline in inflation expectations suggested by those bond market prices could become a factor in September’s meeting.
