I use the term "anchored" to mean relatively insensitive to incoming data. So, for example, if the public experiences a spell of inflation higher than their long-run expectation, but their long-run expectation of inflation changes little as a result, then inflation expectations are well anchored. If, on the other hand, the public reacts to a short period of higher-than-expected inflation by marking up their long-run expectation considerably, then expectations are poorly anchored.
On the face of it, there is something smelly about US inflation expectations. As measured by the difference between indexed linked and conventional styled bonds the unadjusted data are laughing at the notion of rising, corrosive prices (Exhibit 1).Fortunately, since it ought to square with observed happenings, this data set can be adjusted (via an artful process performed by the Cleveland Fed). The main (but not only) variable to compensate for is the difference in relative market sizes of conventional bonds (large) and indexed linked bonds (much smaller).
This disparity makes the underlying securities behave differently when, like now, an environment of financial stress prevails. At such times the premium investors demand for holding the less liquid indexed-linked bonds rises. Implied inflation expectations tend as a result to be understated.
Exhibit 2
Adjusted (Exhibit 2), the data appear to now show that the belief inflation is contained - or "well anchored" as defined above by Mr Bernanke - is being severely tested. But there is still no obvious sign in the measure that either labour or capital have joined the sect of runaway prices in great numbers - after all everything went to plan over the period 2000-2006 (Exhibit 3). That said, at 3.3% the adjusted measure is now at its highest since 1997 and on a par with the consistently over pessimistic Michigan Survey.Exhibit 3
The religion of well-anchored expectations, also known as Fed credibility, believes in the central bank's capacity to cap long term inflation. This stops producers trying to pass along short term price increases; and labour from turning out in Main Street for higher wages (except where GM lives). Virtuous circle rather than wage-price spiral.If that faith swoons, as it risks doing, the high priests at the Fed will have serious proselytizing to do.
Related links:
Rise in US expectations a concern
Fed's language unusually clear on rate cuts
US Growth stronger than thought
US big ticket items beat forecast
Is Paul Volker right? Not this time
Reuters/University of Michigan Surveys
Inflation expectations, how the market speaks
Can TIPS help identify long term inflation expectations?
Inflation takes over as Public Enemy number 1
0 comments
Post a Comment