U.S. INFLATION FEARS RISE AFTER QE3 / THE FINANCIAL TIMES

Last updated:September 17, 2012 9:37 pm

US inflation fears rise after QE3
 

By Michael Mackenzie in New York

 

 

Bond investors pushed a key measure of US inflation expectations on Monday to their highest level since 2006, in response to last week’s aggressive policy action by the Federal Reserve.
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Market expectations for US inflation over the next 10 years rose as high as 2.73 per cent on Monday, based on the difference or the so-called “break-even rate” between nominal and inflation-protected Treasury debt.

 

 

That represents the highest intraday break-even rate since May 2006 and near the all-time closing peak of 2.78 per cent from March 2005.



In volatile trading, the inflation measure had subsequently eased to around 2.59 per cent late on Monday. The break-even rate remains sharply up from last week’s low of 2.35 per cent, before US policy makers announced a third round of bond purchases, or quantitative easing.



The surge in expectations of future inflation has been accompanied by a weaker dollar, higher gold and oil prices as investors view QE as heightening the risk of rising consumer prices in the future.
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Unlike prior episodes of QE in late 2008 and 2010 when inflation break-evens were much lower and suggesting the spectre of deflation, the Fed is deploying QE3 in order to boost employment. The central bank is also keeping bond purchases open-ended and has extended its guidance for maintaining low rates into 2015.
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That has sparked concern among investors that the central bank is prepared to tolerate a much higher inflation rate in the future, propelling the pronounced rise in break-evens over recent days. .
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“Break-even inflation rates do appear to be moving upwards in a structural way, after the potential regime change at the Fed,” said Michael Pond, strategist at Barclays. “The Fed is more focused on reducing unemployment and is prepared to tolerate higher inflation.”



Expectations for inflation over the next five years shot up as high as 2.47 per cent on Monday, after trading at 1.99 per cent early last week.

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“The unlimited expansion of the Fed’s balance sheet is good news for the economy, but it increases the potential tail risk of higher inflation in the future,” said James Evans, senior vice-president at Brown Brothers Harriman.



The spike higher in break-evens may not deter investors from Thursday’s sale of 10-year Treasury Inflation Protected Securities as investors price in the risk that inflation expectations are entering a higher range against the backdrop of a Fed seeking to boost growth at the relative expense of price stability.
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“The asset allocation trade into TIPS will likely continue for sometime, especially as the Fed announced further balance sheet expansion measures to boost growth,” said Mr Pond.


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Copyright The Financial Times Limited 2012.