Expert Commentary

Deflation Expectations Rising

The chart below shows that price-inflation expectations in the U.S.A are collapsing. The U.S. Treasury Inflation-Protected Securities (TIPS) 5-year "breakeven" rate is the difference between its yield and the rate on a 5-year Treasury bond that is not protected for inflation. In this context, inflation refers to price-inflation, the annual rate-of-change of the Consumer Price Index. The breakeven rate, therefore, is a gauge of what the average rate of price inflation is expected by financial markets across the tenor of the bond, in this case 5 years.

As we can see, price-inflation expectations plummeted during the global financial crisis of 2008, going below zero meaning that declining prices (i.e.: price-DEflation) were expected. Since 2010, the 5-year breakeven rate has hovered between around 1% and 2% but notice that it has been making lower highs since 2005. That shows that disinflation expectations, an ever-slowing rate of price-inflation, have been prevalent for many years.

In fact, the 5-year breakeven rate topped out in 2018 and has been declining since. Now, with the current economic crisis upon us, price-inflation expectations are, once again, collapsing. EWI colleague Jordan Kotick has noted a major downward reversal in the TIPS ETF (ticker TIP) which points to the same thing.

The Coronavirus-led shutdown of economies is a supply-shock which, if demand held up, could lead to slower economic growth but higher consumer prices, or "stagflation." However, what this breakdown in the 5-year breakeven rate is warning of is that it is not just supply that is tanking, demand is too.

Lower demand is consistent with a negative trend in social mood and so perhaps it's not just monetary or debt-deflation that is coming hurtling down the tracks, there's an increasing probability that price-deflation is too.

US Price Inflation Expectations