TIPS show inflation alarm fading as options give Fed time

Inflation Credibility

“The Fed will be proven right, that hyper-inflation will not be a consequence of their actions and that they will be able to execute an exit strategy well before those consequences may surface,” Wan-Chong Kung, a money manager in Minneapolis at Nuveen Asset Management, said in a Sept. 25 interview, referring to a tightening of policy. Nuveen oversees more than $100 billion in bonds.

The Fed has built up three decades of inflation-fighting credibility, first with Paul Volcker and then with Alan Greenspan, with the consumer price index average 2.2 percent over the last 5 years, down from almost 15 percent in 1980.

“For the last thirty years the central bank has done everything they can to increase inflation credibility,” Eric Green, global head of rates and foreign-exchange research at TD Securities Inc. in New York and a former economist at the New York Fed, said in an interview on Sept. 25. “Now they are withdrawing the deposit on that.”

Wages, Spending

Bernanke is getting help from the weak labor market. The government may say Oct. 5 that the unemployment rate held above 8 percent for the 44th straight month in September, according to the median estimate of more than 60 economists by Bloomberg.

Wages grew 1.7 percent in August from a year earlier, down from more than 3.5 percent in early 2009. Consumer spending rose 0.1 percent in August after adjusting for inflation following a 0.4 percent gain in July, the Commerce Department said Sept. 28.

“Our policy approach doesn’t involve intentionally trying to raise inflation,” Bernanke said in response to a question during a Sept. 13 press conference. “The idea is to make sure we provide enough support so the economy will grow fast enough to bring unemployment down over time.”

The Fed’s own measure of inflation expectations, the five- year, five-year forward breakeven rate was 2.68 percent on Sept. 26, after reaching a 13-month high of 2.88 percent the day after the Fed’s QE3 announcement. The gauge projects the expected pace of consumer price increases over the five year period beginning 2017.

Investors “pushing break-even rates higher are concerned about medium-term to longer-term inflation, or that is, two to five years from now,” said William O’Donnell, head U.S. government-bond strategist at RBS Securities Inc. in Stamford, Connecticut, one of 21 primary dealers that trade with the central bank. “The inflation that we are pretty sure the Fed fears most, wage inflation, shows no imminent threat.”

Bloomberg News

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