What Inflation?

By Hightower Omaha on December 22, 2023

December 22, 2023

Just a quick Market Commentary this week to point out something that I thought was kind of interesting. The first chart below shows the extreme volatility in interest rates since COVID arrived. Most economists attribute the rapid increase and then subsequent decline in interest rates to the surge in inflation caused by both the pandemic and the massive policy responses to the pandemic. I don’t really disagree. Inflation surged, and now it is coming back down. 

But then I looked at historical breakeven inflation rates for the past four years. Breakeven inflation rates represent the average annual inflation rates expected by bond investors over different bond maturities. They can be calculated by subtracting the rates offered on Treasury Inflation-Protected securities, or “TIPs,” from nominal Treasury rates, which are just the rates we hear quoted in the media. You can see that with the exception of a roughly 10-month period from late-2021 to mid-2022 and a very short stint in early 2023, the 2-year breakeven rates have stayed below 3%. As for the 10-year breakeven rates, they remained below 3% for the entire time with the exception of one day (April 21, 2022). Both 2-year and 10-year breakeven rates are now back to levels (2.14% and 2.20%, respectively) that suggest investors are largely unconcerned about the longer-term threat of inflation.

I guess my point is that investors only lost confidence in the Fed’s ability to wrangle inflation for a “hot minute” (this is an expression used by millennials to describe a very short period of time). It’s striking, to me anyway, that investors have maintained such confidence in the central bank, especially after the Fed was proven wrong (according to many people) about the initial surge in inflation by calling it “transitory.” Even after that error, though, the Fed quickly regained its credibility, and it remains firmly intact today. Will investors’ confidence in the Fed prove to be misplaced?

As most of you know, my belief is that inflation is yesterday’s concern. Yes, a big surge in oil could cause some near-term price volatility, but the pig is now through the python. There are other threats to the economy and markets for sure, but as of right now I don’t see inflation being one of them. 

Peace,

Michael