• Breakeven rates show subdued expectations even after stimulus
  • Outlook makes 10-year inflation-linked offering a hard sell

Bond investors are skeptical that inflation will rebound as the U.S. economy eventually starts to recover.

While some lawmakers fretted this week that a combination of central bank and government rescue packages could inflame long-dormant price pressures, the market’s outlook for inflation has languished. Investors aren’t betting on outright deflation over the longer term, but the 10-year breakeven rate — a gauge of traders’ expectations for the consumer price index over the next decade based on Treasury prices — is hovering around 1.15%. The 30-year is less than half a percentage point higher.

That means investors don’t see the Federal Reserve getting close to its 2% inflation target before 2050. That outlook isn’t a great set up for the Treasury’s $12 billion sale of 10-year inflation-linked bonds Thursday. The historic slump in West Texas crude oil prices, which have clawed back from below zero to trade above $34 a barrel, and last month’s record decline in an index of core consumer prices, contribute to the case against inflation protection.

“We have to get through the deflation before we worry about the inflation,” Kathy Jones, a fixed income strategist at Charles Schwab, said at a virtual roundtable Wednesday. “We’re not in the high inflation camp.”

Inflation hawks have made the case that the multi-trillion dollar combination fiscal spending and Fed liquidity programs will stoke price pressures as the economy revives. A similar argument, focused on the three rounds of quantitative easing that followed the 2008 crisis, proved unfounded, as inflation has slunk below 2% for much of the past decade, too.

“The view that central bank QE and the surge in the money supply will be inflationary is a particular bugbear of ours,” said Steven Major, head of fixed-income research at HSBC. He takes issue with forecasts that price pressures will spring back from a short-lived threat of deflation: “In our opinion this represents a version of the market expectations that have proved so wrong over the last decade.”

Major points out that the overhang of government debt has been one of the biggest drags on inflation globally, and that’s only about to increase.

Reopening Crossroads

But this is a different type of crisis, and economic repair may not seem such a distant prospect to many as businesses shuttered by the coronavirus pandemic begin to reopen around the country. Fed Chairman Jerome Powell said this week that economic growth should start to recover in the second half of this year, although his estimate is based on a successful restart scenario. The possibility of either a second wave of the virus or a pickup in infections that justifies another stretch of quarantine remain a potential concern, and fund managers responding to Bank of America’s latest monthly survey, published Wednesday, identified that as their top tail risk.

“Breakevens are stuck in this low environment and probably won’t be moving a lot until we get a change in view on the path for reopening the economy,” said Michael Pond, inflation strategist at Barclays.

In the meantime, plotting a course for inflation is far from simple, since the data tell a different story depending on which components you’re looking at. Friday’s University of Michigan survey of consumers showed inflation expectations over the next 12 months made its biggest jump in more than nine years, to 3%, as households in quarantine noticed a surge in their grocery bills.

Why Do Consumers See Inflation? What They’re Buying Costs More

Money manager Tim Magnusson at Garda Capital Partners has questions about how measures are being taken for swathes of the economy that aren’t functioning right now, such as rents that aren’t being paid and how the drop in airline capacity is getting reflected in transport costs. But that’s not why he’s not buying at this TIPS auction. The market may weaken as one of its bigger buyers of late, the New York Fed, tapers its asset purchases.

“We’re really interested to see how the market finds its own footing again, meaning the supply/demand balance without the Fed being as heavy handed,” Magnusson said.

To contact the reporter on this story:
Emily Barrett in New York at [email protected]

To contact the editors responsible for this story:
Benjamin Purvis at [email protected]