The U.S. inflation-linked bond (TIPS) market is in an interesting position right now. Inflation protection seems cheap, but the question always remains: is it cheap for a reason? Unfortunately, I am not able to answer that question, I am going to just briefly outline the debate….
Bond EconomicsThe breakeven inflation rate is a market-based measure of expected inflation. It is the difference between the yield of a nominal bond and an inflation-linked bond of the same maturity.
Since investors' money is on the line, they presumably have an interest in pricing inflation correctly. It is viewed as a more reliable measure of inflation expectations than those measured by surveys. In this article, I explain how this concept is used in bond market economic analysis.
Central bankers closely monitor inflation expectations because they’re an important determinant of actual inflation. Treasury inflation-protected securities (TIPS) are commonly used to measure bond market inflation expectations. Unfortunately, they were only introduced in 1997, so historical data are limited. We propose a solution to this problem by using the relationship between TIPS yields and other data with a longer history to construct synthetic TIPS rates going back to 1971.FRBNY — Liberty Street Economics
One could argue that this is a positive development for the US consumer because it could mean price stability. However this move in TIPS certainly raises the risk of near-term deflation, driven by weak demand growth. Anddeflation is notoriously difficult to get under control. This feels (though only in the near term) a bit like Japan, a nation quite familiar with zero to negative inflation expectations.Read it at Credit Writedown
