Fed chair Janet Yellen keeps repeating the mantra “inflation expectations are well anchored”.
They’re not, and I can prove it with a pair of chart on 5-year and 10-year “breakeven” interest rates. The breakeven rate is the difference in yield between inflation-protected and nominal debt of the same maturity.
Falling breakeven rates indicate decreasing expectations of future inflation.
5-Year and 10-Year Breakeven Rates 2012-Present
5-Year and 10-Year Breakeven Rates 2006-Present
What Me Worry?
Earlier today, MarketWatch economic director Steve Goldstein posted a chart of breakeven rates and inflation swaps with the headline Here’s Why the Fed Doesn’t Trust This Chart.
Curiously, the chart was from a year ago and so was Goldstein’s analysis.
I was wondering why the chart stopped in February of 2015. The reason came moments later when the article referred to Fed testimony not today, but also a year ago.
Yet Fed officials — notably Fed Chairwoman Janet Yellen — say that inflation expectations are stable.
In a section of the Fed’s semi-annual report on monetary policy released Wednesday, the central bank explains why they don’t believe this chart reflects a real decline in inflation expectations: The spreads pictured in the chart also bake in an inflation-risk premium, as well as other premiums driven by liquidity differences.
The Fed notes that surveys from primary dealers find their inflation expectations have been basically stable since last summer. Professional forecasters, too, haven’t changed their expectations much.
The article to which Goldstein referred was the Monetary Policy Report submitted to the Congress on February 24, 2015.
February 10, 2016 Speech
Goldstein is correct in his statement the Fed is not worried, even though he has the wrong year. Here is a snip from Chair Janet Yellen’s Semiannual Monetary Policy Report to Congress Before the Committee on Financial Services, U.S. House of Representatives, Washington, D.C. February 10, 2016.
Current Economic Situation and Outlook
Since my appearance before this Committee last July, the economy has made further progress toward the Federal Reserve’s objective of maximum employment. And while inflation is expected to remain low in the near term, in part because of the further declines in energy prices, the Federal Open Market Committee (FOMC) expects that inflation will rise to its 2 percent objective over the medium term.
What Me Worry?
Yellen has a “What, Me Worry?” attitude because she believes falling inflation expectations are due primarily to falling energy prices.
Yellen ought to be worried because the Fed clearly blew another asset bubble with insane amounts of QE. Inflation did not rear its head in the CPI, but rather in stock prices, junk bond prices, and housing.
Now, the global economy faces another crippling round of asset deflation, and quite possibly CPI deflation as well.
Low interest rates foster economic bubbles. And it’s asset deflation not CPI deflation that central banks ought to fear. Even the BIS agrees with that statement. For discussion please see Historical Perspective on CPI Deflations: How Damaging are They?
Economic Challenge to Keynesians
Of all the widely believed but patently false economic beliefs is the absurd notion that falling consumer prices are bad for the economy and something must be done about them.
I have commented on this many times and have been vindicated not only by sound economic theory but also by actual historical examples.
My January 20, post Deflation Bonanza! (And the Fool’s Mission to Stop It) has a good synopsis.
And my Challenge to Keynesians “Prove Rising Prices Provide an Overall Economic Benefit” has gone unanswered.
In their attempts to fight routine consumer price deflation, central bankers create very destructive asset bubbles that eventually collapse, setting off what they should fear – asset bubble deflations following a buildup of bank credit on inflated assets.
Mike “Mish” Shedlock