reluctantQuant

Rising Long-Term Interest Rates Go Hand in Hand with the Expanding Economy

Hmmm... no examination of TIPs implied inflation breakevens? Not rocket science, albeit imperfect. Better if you use a pair of constant maturity indices. I'll use 7-year, since 7 is such a lucky number (especially in, say.. October 2007). Note to non-bond-geeks: If I have a seven year nominal treasury and a seven year inflation-protected treasury, the simple yield difference is a simple indicator of the inflation premium paid by the nominal bond above the inflation protected security. Note to true bond-geeks: yeah, there are devils in the details, so just take it with a basis-point of salt.

so here are the month end values for the last year...
06/30/2008 2.44
07/31/2008 2.16
08/29/2008 1.97
09/30/2008 1.23
10/31/2008 -0.61
11/28/2008 -1.43
12/31/2008 -0.09
01/30/2009 0.73
02/27/2009 1.00
03/31/2009 1.14
04/30/2009 1.29

Wadda we see? Well, yes, inflation expectations are indeed rising, but the first half of 2008 averaged about 2.25. And interestingly enough, it's never broken 2.90 on a weekly chart. Again, this is 7 year forward expectations. I'd say that BondLand is indeed out of "disinflation mode" - as we would expect. When this gets north of 2.50, then the inflation concern gets interesting. The bond market is a better forecaster than most, and it's not yet buying the hyperinflation trade. Supply and demand dislocations between FRB/UST action, Dealer balance sheet stress and unwinding the flight to quality trade are much larger factors in today's market posture. Those factors MUST be included in any short term rate move interpretations. This inflation indicator is based on very very large capital flows, folks. Something to watch. Not screaming yet. Stay tuned.


--rq