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How much inflation is the market expecting?

You may have noticed some talk in recent days about Treasury selling inflation-protected bonds at a negative yield. This talk may have made your eyes glaze over. The short version is that it means investors think the Federal Reserve will be successful in its efforts to pump some inflation into the economy. But how successful? Annie Lowrey* crunched the numbers and found that "annual inflation for the next five years needs to be somewhere north of about 1.55 percent for the investors to break even. Any more inflation than that, and they make money."

That's better than no inflation, but it's well below the Federal Reserve's target of 2 percent.

By Ezra Klein  | October 27, 2010; 11:10 AM ET
Categories:  Federal Reserve  
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Errrr....anyone watching the precious metals markets saw the signals. And even the other commodities such as grains, oils, and meats got the message.

So, now it's somehow news?

Posted by: WrongfulDeath | October 27, 2010 11:55 AM | Report abuse

If you understand inflation, you understand that 1.55 is not realistic number. If the economy starts to recover in any way, the inflation numbers will leap, not mathematically progress. The current craze in the equity market to sell long term debt i.e. Goldman this week, shows that they are very happy to lock in these numbers in anticipation of a tidal wave later.

Posted by: 54465446 | October 27, 2010 1:08 PM | Report abuse

It doesn't necessarily think they're expecting anything in particular in terms of annual inflation. They could be expecting several years of deflation followed by big jumps in inflation. That was my expectation when I bought some 10 year TIPS about a year ago.

Posted by: bgmma50 | October 27, 2010 1:18 PM | Report abuse

It doesn't necessarily think they're expecting anything in particular in terms of annual inflation. They could be expecting several years of deflation followed by big jumps in inflation. That was my expectation when I bought some 10 year TIPS about a year ago. (TIPS have downside protection from deflation)

Posted by: bgmma50 | October 27, 2010 1:27 PM | Report abuse

Plus, the marginal investor probably wants to do slightly better than breakeven, especially given the risk that inflation could undershoot.

Also, is there really a huge difference between 1.55% and 2.00%? How much does your unemployment expectations change if you shift your inflation forecast by 0.45% annually?

Posted by: justin84 | October 27, 2010 1:47 PM | Report abuse

OMG. Bill Gross on QE is a must read. I bring you "Run Turkey Run".

Posted by: bgmma50 | October 27, 2010 2:13 PM | Report abuse

If inflation only runs 1.55 for the next five years then say hello to President Palin in year three because it will mean that the economy is in the toilet. With the amount of currency debasement that has gone on, only a wildly unsuccessful economy could continue with that rate. Unlike economists the people who bought the Treasuries actually had money at stake. I'll take their estimates.

Posted by: 54465446 | October 27, 2010 3:03 PM | Report abuse

Ezra, you spend a lot of time speaking to and about ecnomists like Paul Krugman and Dean Baker, who have nothing to lose. Have a talk with Jeremy Grantham who runs his own money.

Here is a highlight or two from his morning news release:

"The investment manager said if he were a "benevolent dictator," he would "strip the Fed of its obligation to worry about the economy and ask it to limit its meddling to attempting to manage inflation."

The problem with quantitative easing—the Fed policy of stimulating the economy through actions such as purchases of long-term debt—is it has historically led to the creation of more debt in the economy, as well as higher asset prices, and has not led to higher rates of GDP growth, Grantham said"

Posted by: 54465446 | October 27, 2010 3:07 PM | Report abuse

Looking at a few charts, it appears that commodities had a period of relative stability if not actual decline up until around 2000 - 2002, and then they started to take off. During the crash, commodities fell, and I would assume that if things went back to normal, then commodities would resume the climb we saw prior to 2009. Even in a world of perfect monetary policy, if you have large groups of people (China, India ect) who are producing (and then consuming) increasing amounts of wealth due to productivity increases, you could see pressure on commodity prices. I think we are past the point, where the first world countries alone can determine whether commodity prices move up or down. I am not saying that commodity price increases are not inflationary, just that they may not be responsive to policies of the fed.

Posted by: henryj99 | October 27, 2010 3:32 PM | Report abuse

I understand the impulse, but you need to stop bragging that you're going out (or involved with, or whatever the modern word is) with Annie Lowrey. ;-)

Posted by: bdballard | October 27, 2010 4:54 PM | Report abuse

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