Declining Inflation Expectations, June 2021

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SimpleGift
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Declining Inflation Expectations, June 2021

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After rising steadily since January 2021, the bond market's expectations for future inflation have now been trending lower for nearly a month. The chart below shows breakeven inflation rates for the 2-year, 5-year and 10-year maturities. Breakeven rates are simply the difference between the yield of a nominal bond and an inflation-linked bond of the same maturity.
  • Image
    NOTE: Strictly, breakeven rates and expected inflation are not exactly the same, since the breakeven rates
    do not consider the inflation risk premium (which pushes inflation compensation up) and the TIPS liquidity
    premium (which pushes inflation compensation down) — but are close enough for a general discussion.

    Data source: Breakeven inflation rates from Federal Reserve models.
These bond market forecasts of future inflation are far from infallible, but they do represent the best current estimates by bond investors around the world, all of whom have real money riding on their projections.

Hopefully, Boglehead investors have their portfolios well prepared for any level of future inflation, low or high.
Johnathon Livingston
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Re: Declining Inflation Expectations, June 2021

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Thanks for sharing.
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nedsaid
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Re: Declining Inflation Expectations, June 2021

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I have been watching the US Treasury Yield curve and I want to say that things look rather encouraging on the inflation front. I for one do not want to see a resurgence of inflation. My parents were fanatics about inflation they lived it in the last half of the 1940's and again in the 1970's. A reminder it is all about purchasing power and not just dollars. Accordingly I have been an inflation hawk myself keeping my eyes peeled for the first sign of inflation and constructing my portfolio accordingly. I won't fire until I see the whites of inflation's eyes, pretty much means buying more TIPS and perhaps taking even more drastic action. But so far, so good. Thanks Simple Gift.
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scout1
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Re: Declining Inflation Expectations, June 2021

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Keep up the good work. Everyone was getting riled up a few months ago about inflation and you did a great job encouraging people to keep a level head.
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SimpleGift
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Re: Declining Inflation Expectations, June 2021

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scout1 wrote: Wed Jun 23, 2021 8:07 pm Everyone was getting riled up a few months ago about inflation...
Right, but the odd thing was that the bond markets have been very consistent in their expectations of only a temporary surge in inflation for almost 6 months now, since early in 2021.

Note in the chart below that the 2-year breakeven rate (in blue) rose above the 5-year and 10-year breakeven rates in January 2021 — meaning that bond investors have been forecasting only a temporary rise in inflation out to 2 years, with decreasing inflation thereafter.
The bond markets today are still expecting this same inflation dynamic, but just at lower (and decreasing) inflation levels.
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Re: Declining Inflation Expectations, June 2021

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The premise of all of this is that the bond market is a solid predictor of inflation. Is the premise true? I'm skeptical that graphs of easily assembled historical information actually predict the future. If it does, we can get rich together. If it doesn't then it’s nothing but an interesting tidbit of little note.

When you get right down to it, future inflation will be based on the future actions of a few individuals, whose identities will change over time and are currently unknown. In the past, the actions of these individuals have caused outcomes that they didn’t even expect. To be correct, the bond market would have to accurately estimate what those future individuals will believe, that they will take certain actions based on those beliefs, and that their actions will have the desired effect. This is to say nothing of future external events beyond everyone's control.

Given all this, how can anything be a useful predictor of these unknown future individual's unknown future actions?

JT
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SimpleGift
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Re: Declining Inflation Expectations, June 2021

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bottlecap wrote: Thu Jun 24, 2021 7:22 am Given all this, how can anything be a useful predictor of these unknown future individual's unknown future actions?
Studies have shown the accuracy of breakeven inflation rates as a predictor of future inflation to be highly variable, and also period dependent — i.e., for some periods in some studies, breakeven rates were useful and fairly accurate, and in other studies of other periods they were wildly off the mark.

The value of looking at breakeven inflation rates, to my mind, is as an indicator of sentiment by global bond investors at any point in time. And it's a crowd-sourced, market-derived sentiment that is one of the inputs into the decision-making of the Federal Reserve's Open Market Committee — the few individuals whose future actions really will count!
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JoMoney
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Re: Declining Inflation Expectations, June 2021

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Is the Fed still buying in the market? I have a hard time accepting a deconstruction/explanation of what "the market" is projecting when the largest participant (overwhelming everything else) has been an entity with very different objectives then any individual investor.
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Re: Declining Inflation Expectations, June 2021

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JoMoney wrote: Thu Jun 24, 2021 8:17 am Is the Fed still buying in the market? I have a hard time accepting a deconstruction/explanation of what "the market" is projecting when the largest participant (overwhelming everything else) has been an entity with very different objectives then any individual investor.
They are thinking about talking about slowing their monthly purchases so yes, still very much impacting the market for bonds right now.
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Parkinglotracer
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Re: Declining Inflation Expectations, June 2021

Post by Parkinglotracer »

What I see in reality with my eyes and pocket book is inflation, inflation, inflation

- Gas is up
- Cars are up
- Home prices are up
- Boats are up
- Food is up
- Furniture is up

what I see on the TV is the Fed and Company trying to tell everyone inflation is short lived (because if it is not the Fed is in a tough spot, Deficit interest will bloom, and the economy will be hurt)

I see the Gov spending like a drunkin sailor and continuing buying bonds artificially keeping rates low

I see interest rates (say 10 year) back off as the Fed speaks and short term traders don't like to fight the Fed

I am prepared for inflation or not

The non equity part of my portfolio (say 40%) is in less interest rate sensitive accounts

- Oct 2000 I Bonds ~5-6%
- May 2021 TIPS ~3%
- Vanguard TIPs Fund VTIP ?%
- Vanguard Money Market Funds 0%
- USG Thrift Savings Plan Stable Value Fund (1-2%)
- Toyota Income Drive Account 1.35%
- Looking at MYGA as per forum discussion

If you can see I don't trust the Gov or anyone's predictions but my eyes and wallet tell me some reality

No One knows Nothing as smart people here say ... but if interest rates jump 1% BND will go down by the amount of its duration .. say 5-7%

I will gladly give up the low BND returns for removing the risk of rising interest rates from my portfolio - short duration bonds and cash is king in my opinion

Clearly other strategies and techniques are as smart or smarter than mine ...
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Re: Declining Inflation Expectations, June 2021

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On the latest Jesse Felder podcast, Julian Bridgen discussed a model which points to the likelihood of inflation peaking at 10% to 15%. Personally I do hope for double digit inflation because I am better positioned for it than the majority of investors, their loss would be my gain. It would also serve to indirectly redistribute wealth from the older 50% of the population to the younger 50%.
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SimpleGift
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Re: Declining Inflation Expectations, June 2021

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JoMoney wrote: Thu Jun 24, 2021 8:17 am Is the Fed still buying in the market? I have a hard time accepting a deconstruction/explanation of what "the market" is projecting when the largest participant (overwhelming everything else) has been an entity with very different objectives then any individual investor.
Interesting question. Looking at some data, it appears the Fed has been a buyer of both TIPS and nominal Treasuries in roughly consistent proportional amounts in recent years (chart below):
However, because the supply of nominal Treasuries (new issuance) has outpaced the supply of TIPS over the past year, this recent study suggests that this imbalance may have contributed in some degree to the rise of breakeven inflation rates in 2020. But the study offers no quantitative assessment of how much that contribution may have been, and at what bond maturities, etc.

My sense is that Fed bond purchases have had some effect on breakeven inflation rates, but not to the point of overwhelming the market sentiment.
GordDownie
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Re: Declining Inflation Expectations, June 2021

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Forester wrote: Thu Jun 24, 2021 9:09 am On the latest Jesse Felder podcast, Julian Bridgen discussed a model which points to the likelihood of inflation peaking at 10% to 15%. Personally I do hope for double digit inflation because I am better positioned for it than the majority of investors, their loss would be my gain. It would also serve to indirectly redistribute wealth from the older 50% of the population to the younger 50%.
How have you positioned yourself? What sort of actions have you taken? I have started a separate thread looking for information such as this.

Thanks
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Forester
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Re: Declining Inflation Expectations, June 2021

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GordDownie wrote: Thu Jun 24, 2021 11:39 am
Forester wrote: Thu Jun 24, 2021 9:09 am On the latest Jesse Felder podcast, Julian Bridgen discussed a model which points to the likelihood of inflation peaking at 10% to 15%. Personally I do hope for double digit inflation because I am better positioned for it than the majority of investors, their loss would be my gain. It would also serve to indirectly redistribute wealth from the older 50% of the population to the younger 50%.
How have you positioned yourself? What sort of actions have you taken? I have started a separate thread looking for information such as this.

Thanks
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bottlecap
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Re: Declining Inflation Expectations, June 2021

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SimpleGift wrote: Thu Jun 24, 2021 7:58 am
bottlecap wrote: Thu Jun 24, 2021 7:22 am Given all this, how can anything be a useful predictor of these unknown future individual's unknown future actions?
Studies have shown the accuracy of breakeven inflation rates as a predictor of future inflation to be highly variable, and also period dependent — i.e., for some periods in some studies, breakeven rates were useful and fairly accurate, and in other studies of other periods they were wildly off the mark.

The value of looking at breakeven inflation rates, to my mind, is as an indicator of sentiment by global bond investors at any point in time. And it's a crowd-sourced, market-derived sentiment that is one of the inputs into the decision-making of the Federal Reserve's Open Market Committee — the few individuals whose future actions really will count!
Interestingly, this is similar to the sentiment of global economists. Aside from some outliers, the vast majority make projections that predict things will continue on as they have in the recent past. When things don't, and then they are wildly off the mark.

This raises the very real possibility that the sentiment of bond investors, like that of economists, is not actually predictive, but can appear that way for stretches of time. Correlation is not causation and sometimes this time really is different. No one knows when, though.

JT
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SimpleGift
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Re: Declining Inflation Expectations, June 2021

Post by SimpleGift »

bottlecap wrote: Thu Jun 24, 2021 1:43 pm Interestingly, this is similar to the sentiment of global economists. Aside from some outliers, the vast majority make projections that predict things will continue on as they have in the recent past. When things don't, and then they are wildly off the mark.

This raises the very real possibility that the sentiment of bond investors, like that of economists, is not actually predictive, but can appear that way for stretches of time. Correlation is not causation and sometimes this time really is different. No one knows when, though.
What you're saying makes good sense. Several studies have shown that breakeven inflation rates have a much higher correlation with past inflation than future inflation — indicating that bond investors tend to be more often anchored on past trends than accurately predicting future trends.

So one needs to be careful to view breakeven inflation rates for what they are — not as a solid forecast per say, but rather simply as market expectations, which can and will change. For this reason, Boglehead investors are much better served by constructing their portfolios in advance to anticipate various levels of inflation — low to high — rather than trying to adjust their allocations on the fly, based on someone's latest inflation forecast model.
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