Treasury Market’s Inflation Gauge Nears 2%, Highest Since 2018

For the first time in two years, bond investors are betting that U.S. inflation will average close to 2% per year over the coming decade.

The market’s key measure of price expectations reached 1.981% on Tuesday after touching 1.992% Monday, the highest since December 2018, data compiled by Bloomberg show. The gauge, known as the breakeven rate, is gaining momentum as traders prepare for an economic recovery in 2021 now that a Brexit deal has been reached and as U.S. legislators have approved additional virus-relief aid. The roll-out of vaccinations against the coronavirus is also fueling the move higher.

It’s all happening against the backdrop of the Federal Reserve’s push to revive inflation, which has been too low for years. In August, policy makers unveiled an extensively previewed new approach, under which they will seek inflation that averages 2% over time by allowing price pressures to overshoot after periods of weakness. One key to that effort, officials have said, is the need to buoy expectations for inflation.

Treasury Market’s Inflation Gauge Nears 2%, Highest Since 2018

“The reflation trade is alive and well,” said Com Crocker, an investment strategist at New Century Advisors. Treasury Inflation-Protected Securities -- from which breakevens are derived -- are moving as investors “look ahead to the post-vaccine economic reopening, aided by the rally in commodities, the weaker dollar, Yellen heading to Treasury, and talk out of the incoming Biden administration of more stimulus and an infrastructure plan,” he said.

As expressed through regular Treasuries, the reflation trade has struggled to take flight this year, as expectations that the Fed could step in if rates unmoor have kept a lid on nominal yields.

The breakeven rate is the difference between the yields on Treasuries and TIPS, and represents investors’ projection for the average annual consumer price index over the life of the security. Investors accept lower yields on TIPS because the debt pays interest on a principal amount that increases with the CPI.

Aided by a rebound in energy prices, the breakeven rate has widened steadily since mid-November, when Joe Biden won the U.S. presidential election. Biden has nominated former Fed Chair Janet Yellen to head the Treasury, which some investors see signaling the potential for stronger cooperation between the department and the central bank in charting an economic revival.

The Fed’s push on inflation and its pledge to keep interest rates near zero indefinitely has eroded demand for the U.S. currency, sending the Bloomberg Dollar Spot Index to the lowest level since 2018 and the Bloomberg Commodity Index to the highest level since January.

©2020 Bloomberg L.P.

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