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Market Reassurance on Inflation Control

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4.7

Andrew R. Michaud

• December 07, 2023

Market-implied expectations for inflation over the next 10 years are slipping closer to 2% amid renewed confidence that the Federal Reserve will manage to control price gains in the long run.

Breakeven Rate Indicates Improved Sentiment

The 10-year breakeven rate currently stands at approximately 2.14%, down from 2.5% in October. This rate is derived by subtracting the rate on 10-year Treasury inflation-protected securities (which sits at 1.963% as of Thursday afternoon) from the level of the benchmark 10-year Treasury yield (BX:TMUBMUSD10Y). As per Tradeweb data, these figures reveal one of the lowest levels since September.

Rest assured, the market is showing signs of increased reassurance regarding inflation control by the Federal Reserve.

The Inflation Debate: Can Policy Makers Control Rising Prices?

The contentious issue of whether policy makers can effectively contain inflation is currently dominating financial markets. Analysts are divided on the matter, with some believing that inflation will naturally subside as consumers reduce spending on goods and services, as witnessed during the pandemic. However, skeptics argue that both markets and the Federal Reserve have a poor track record in accurately predicting inflation, and progress in bringing price gains back to normal levels has been sluggish.

Market expectations regarding inflation are evident in the stability of the 10-year breakeven rate around 2.5% for an extended period. Kathy Jones, Chief Fixed Income Strategist at Charles Schwab in New York, explains that while there may be some distortion due to limited liquidity, the current 10-year breakeven rate indicates an expectation of long-term equilibrium inflation around the 2% mark. In a phone interview on Thursday, Jones expressed confidence in her forecast that inflation will not reaccelerate, dismissing the notion of persistently high and sticky inflation as lacking empirical evidence.

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Schwab Expects Bond Yields to Decline as Inflation and Economic Growth Slow

As we head into 2024, Schwab has released its fixed income outlook, predicting a decline in bond yields. This projection aligns with the falling inflation and slowing economic growth expected in the coming year. However, uncertainty surrounding the Federal Reserve's policy decisions may contribute to volatility in the market.

On Tuesday, we can expect the release of the November consumer-price index, which will provide key insights into U.S. inflation levels. Unfortunately, inflation, as measured by the CPI's annual headline rate, has remained stubbornly high at or above 3% for the past five months, up until October. The core PCE, the Fed's preferred inflation gauge, also indicated a rate of around 3.5% over the 12-month period ending in October.

As we approach Friday's release of the November nonfarm payrolls report, Treasury yields seem to be holding steady. Currently, the 10-year rate is trading at approximately 4.11%. Additionally, all three major stock indexes (DJIA, SPX, COMP) have shown an upward trend.

Stay tuned for further updates on these market trends as we navigate through the coming weeks and months.