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
Some day far far far into the future … “experts” will figure out that ZIRP(NIRP)QE are disinflationary … and deflationary when asset bubbles burst.
Got Treasuries?
Isn’t sovereign debt the bubble every central bank is trying to create? When those burst, look out below.
Why would they burst*?
*if issued in own currency … which a reserve currency has the luxury. As central bank can QE to its content.
Now, a run on a currency? That is a different story… but in a fiat world King $US will be last man standing (for now … ie: till the coming crisis over).
In fiat central banking a sovereign debt bubble need never burst. However once monetary policy is rejected by the population, or once it has corrupted the fabric of society beyond tolerance, it might equally be look out for below.
Mish,
Your challenge to Keynesians is nebulous. When did Keynes say rising prices was a good thing? He didn’t. What he said was falling prices is a bad thing.
The issue is that both rising and falling prices are good for some people and bad for others. Politics is about deciding who gets to win and who gets to lose.
Dunno what Keynes said … but somehow neo keynesians have equated 2% inflation with price stability.
With productivity gains … the natural path of (many) prices should be lower.
Free price discovery is the natural state, whether up or down, and it is the most beneficial, as capital allocation will be traded by those closest to economic reality.
The problem with the inflation/deflation argument is not that government is setting specific prices, though they claim that to be their aim (and one that is worthy of being labelled economic dictatorship in all its stripes), it is that they are setting the price of money. There is a difference. For example it could be said that they are diluting and hence deflating the price of money while chanelling the diluant to certain ends. Either way, the deflation of the price of money is deemed to satisfy a demand for more money, something which is contradictory as higher demand should see its price increase, not decrease.
Only a central bank could believe that it lives in a world of limitless resources all waiting to be arranged by it.
Bernanke tried for his entire time as chairman to bring about inflation and failed miserably. See his speech on the fear of deflation:
http://www.federalreserve.gov/boarddocs/Speeches/2002/20021121/default.htm
Yellen won’t be able to do any different.
You said (about Keynes): “When did Keynes say rising prices was a good thing? He didn’t. What he said was falling prices is a bad thing.”
Mish said (about Keynsianism): “Of all the widely believed but patently false economic beliefs is the absurd notion that falling consumer prices are bad for the economy”
In other words, Mish did not accuse Keynes of saying rising prices are a good thing. He accused Keynesians of saying of saying that falling prices are a bad thing.
To Jon Sellers who writes
” Mish, Your challenge to Keynesians is nebulous. When did Keynes say rising prices was a good thing? He didn’t. What he said was falling prices is a bad thing. The issue is that both rising and falling prices are good for some people and bad for others. Politics is about deciding who gets to win and who gets to lose.”
Nonsense – My challenge is not nebulous at all. I said there is no economic benefit. And indeed there isn’t. I never stated there were no winners and losers.
Indeed I stated the opposite. I specifically said the winners were those with first access to money: the banks and the already wealthy.
That makes you wrong twice.
Mish
Lacy Hunt has evidence as to why rates can’t be raised and nirp.
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I have been trading Vanguard bond funds for some time now always betting the rates will go back down due to global deflation. I go to VFSUX (ST) until the 10-years Treasury goes above 2.0% then switch to VUSTX (LT). Working like a charm for about the last decade.
The internet, which auctioned our best jobs, has introduced the global economy to a competition to have the cheapest labor and lowest prices. So far we’ve seen it in wages and commodities.
Only food, healthcare and taxes have pricing power the rest is seeking the lowest common denominator.
True price stability is to allow 2% deflation or 2% inflation and NOT PICK A WINNER.
TLT is up 12% during the past 3 months. Dividends were ~3% annually on the Nov. price – down to ~2 1/2% now. 30-treasuries dropped to 2 1/4% a year ago. Closed at 2.53% today, down from 3.07% just a few months ago.
Yellen is being set-up as the “fall guy”… this year & next will probably mark the beginning of the end for the Fed.
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Lol, reminds me of my own, why worry video that I did recently.
https://youtu.be/5JDECkB3tO0
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DON’T YOU HAVE TO HAVE AN ECONOMY IN ORDER TO HAVE INFLATION?