Financial Market Indicators for Expected Inflation, Output

As of yesterday:

Figure 1: Five year inflation breakeven calculated as five year Treasury yield minus five year TIPS yield (dark blue line), five year breakeven adjusted by inflation risk premium and liquidity premium per DKW (light blue thin line), five year five year forward expected inflation calculated  from Treasury and TIPS yields (red), all in %. Source: FRB via FRED, Treasury, Kim, Walsh and Wei (2019) following D’amico, Kim and Wei (DKW) accessed 1/6/2022, and author’s calculations.

There’s a wide gap between the 5 year inflation breakeven (2.87% as of yesterday) and the adjusted-for-premia estimate — 1.28 percentage points as of 12/31.

Figure 5: Five year five year forward expected inflation calculated  from Treasury and TIPS yields (dark blue line), five year breakeven adjusted by inflation risk premium and liquidity premium per DKW (dark red line),  all in %. Source: FRB via FRED, Treasury, Kim, Walsh and Wei (2019) following D’amico, Kim and Wei (DKW) accessed 1/6/2022, and author’s calculations.

The longer term expectations — 5 year average 5 years from now — are falling, and either unadjusted or adjusted are not far from 2% on CPI (not PCE).

Figure 3: 10 year-3 month term spread (dark blue), five year TIPS yield (dark red)), five year average expected real rates fromDKW (pink), all in %. NBER defined recession dates 2/28-4/30/2020. Source: FRB via FRED, Treasury, Kim, Walsh and Wei (2019) following D’amico, Kim and Wei (DKW) accessed 1/6/2022, NBER, and author’s calculations.

Measures of future economic activity, such as the 10 year – 3 month term spread, indicate a slight improvement in optimism, but still not near levels of earlier in the year, like March 2021. Real 5 year rates have been edging upward – since middle of last year using the adjusted series.