When you read about inflation in the financial press, chances are the article will reference the Consumer Price Index (CPI) that is constructed and released by the Bureau of Labor Statistics (BLS). The CPI measures price changes for a basket of goods and services, and it is the most widely cited measure of inflation. It is used to adjust wages, salaries, and pensions, and it is probably one of the most closely watched economic statistics.
CPI is released mid-month by the BLS to reflect price changes in the preceding month. Therefore, CPI is considered to be a lagging indicator; the economic event (inflation) may already be underway.
To get a better understanding of future inflation expectations, investors look at something called “inflation breakeven”, which is the difference between the yields on U.S. Treasury bonds and Treasury Inflation Protection Securities (TIPS) of the same maturity. A quick example using current data will help to illustrate the concept:
10 Year Treasury Rate as of April 18th: 2.87%
10 Year TIPS Rate as of April 18th: .71%
Inflation Breakeven Rate: 2.16%
In other words, as of April 18th, 2018, investors are expecting inflation to average 2.16% per year for the next ten years.
As you can see from the chart below, inflation expectations have been rising steadily since early 2016. The Fed watches the breakeven rate and has acknowledged it is one of their preferred metrics for gauging inflation expectations. Looking at data from 2008 to the present, a move above 2.50% on the breakeven rate may prompt the Fed to move more aggressively in raising interest rates.
Please note, the information contained in this segment is for educational purposes only and does not represent a solicitation or recommendation to buy any security that is mentioned.
Thomas A. McDevitt, CFA, CFP, EA