One year inflation expectations, as tracked by the breakeven rate for U.S. Treasury Inflated Protected Securities (TIPS), have fallen to almost 0%, while the more often quoted two year rate plummeted to 0.7% (see chart). While longer-term inflation expectations have diminished, albeit at a much smaller magnitude, the spread between 2Y and 5Y rates has widened to 90bps from just 20bps a month ago.
Diminishing short-term inflation expectations are a product of traders’ flight to quality leading to among other things falling commodity prices. While short-term breakeven rates will likely remain under pressure as long as developments in Europe control the market; a mounting economic recovery in the U.S. should make it very difficult for short-term breakevens to remain this low indefinitely.
Disclosure: No positions