Most Important Number of the Week Was 1.4%
(Bloomberg Opinion) -- There’s no shortage of economists and investors saying the U.S. is on the cusp of a rapid acceleration in inflation because of the trillions of dollars being pumped into the economy by the government and Federal Reserve just as consumers regain their mobility. The thinking is that this could force the Fed to tighten the purse strings prematurely, halting the strong rally in equities and other riskier assets — or worse. These worrywarts are only half right.
For now, inflation is quiescent. The government said Wednesday that the consumer price index rose just 1.4% in January from a year earlier, far below the Fed’s desired 2% target, helping trigger a rally in the bond market. The February reading should also be tame. Things become more complex after that. The March and April readings are likely to show a spike, but that will most likely be due to a drop in the inflation rate last March and April as the country shut down and people holed up in their homes. The inflation rate fell during those two months by the most since the end of 2014, and April’s decline was the biggest since the height of the financial crisis at the end of 2008, according to data compiled by Bloomberg.
Even so, prepare for a lot of chatter about how Fed Chair Jerome Powell and his colleagues have fallen behind the curve and need to tighten monetary policy at once to keep inflation from roaring out of control. To Powell and his key lieutenants, the coming inflation spike will be viewed as “transient” rather than the more worrisome “incipient” that suggests big gains in consumer prices are becoming entrenched. Powell even reiterated on Wednesday that the central bank is committed to maintaining its $120 billion monthly pace of bond purchases until it sees “substantial further progress” on employment and inflation.
To be sure, it’s hard to argue with the signals being sent by the bond market. The yield curve, or difference between short- and long-term yields, is the steepest since 2017, and breakeven rates on five-year Treasuries are the highest since 2013. Both are traditional indicators that bond investors are pricing in much faster inflation.
But the bond market is not always right, or rather, its signals can be easily misinterpreted. The steeper yield curve is not only due to rising long-term yields, but also a collapse in short-term yields linked to the Treasury Department’s decision to start issuing fewer bills as it prepares to draw down its near-record $1.6 trillion cash balance to cover expenses and comply with federal debt-ceiling rules.
As for breakeven rates, they measure the difference in yields between conventional Treasuries and Treasury Inflation-Protected Securities, or TIPS. The way TIPS work is that their principal rises with the increase in the consumer price index. The knowledge that the CPI is poised jump in a few months is skewing breakeven rates higher. But don’t just take my word for it. HSBC Holdings Plc strategist Steven Major, who for years has correctly forecasted ultra-low bond yields, wrote in a research report this week that rising breakeven rates are tied to investors seeking to pay for protection against the risk of faster inflation as opposed to actually expecting faster inflation.
Perhaps the better bond market measure to watch is real, or after inflation, yields. Those are negative when looking at the benchmark 10-year Treasury, not what one would expect if bond investors were truly worried about surging inflation. In fact, one would expect real yields to be solidly positive to keep rising rates of inflation from eroding the value of a bond’s fixed payments over time.
What about all those $1,400 relief checks and expanded unemployment benefits that Congress is working on injecting into the economy? A survey released this week by Morning Consult and commissioned by Bloomberg News found that any new payments are much more likely to be saved rather than spent. Not only that, Capital Economics points out that many companies were forced to adopt technological advances to weather the pandemic, which will aid productivity gains, keeping inflation in check even as the economy gathers momentum.
Inflation is the bogeyman of markets. Plenty of smart people have been warning against the potential for runaway inflation ever since the Fed began its policy of quantitative easing — printing money to inject directly into the financial system through bond purchases— in the aftermath of the financial crisis more than a decade ago. But it has never materialized. Even the Fed has been unable to solve the puzzle, failing to sustainably achieve its 2% inflation target after it was adopted in 2012 before shifting last year to a strategy in which it would overshoot the goal to make up for shortfalls and average 2% over time.
Will this time be different? It’s always possible, especially with money being pumped directly into the real economy by the government to go along with the Fed’s actions within the financial markets. But that’s probably far down the road. In the meantime, much like there was a “red mirage” in the recent U.S. elections, investors should expect an “inflation mirage” in coming months.
This column does not necessarily reflect the opinion of the editorial board or Bloomberg LP and its owners.
Robert Burgess is the Executive Editor for Bloomberg Opinion. He is the former global Executive Editor in charge of financial markets for Bloomberg News. As managing editor, he led the company’s news coverage of credit markets during the global financial crisis.
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