Looking backward delivered another inspirational session for the bulls in the land of macro today. The US economy grew faster than previously estimated in the second quarter, according to this morning’s revision from the Bureau of Economic Analysis. GDP expanded 4.6% during the three months through this past June (real seasonally adjusted annual rate). That’s the best pace since the end of 2011 and a healthy improvement over last month’s 4.2% gain for Q2. But if growth is picking up, why is Mr. Market’s inflation forecast going down?
A markets-based view of inflation expectations based on government securities (10-month Treasury yield less its inflation-indexed counterpart) has recently dipped to around 2.0% over the past week or so. The 1.99% level in the daily data for September 22 is the lowest since last June, although the numbers for yesterday (Sep. 25) moved up a bit to 2.02%, according to the Treasury’s daily numbers. The key takeaway is that inflation expectations have dropped substantially since the recent peak of just under 2.30% in July.
That’s hardly a radical change in the outlook, although it’s odd once you consider that the central bank is widely reported to be on track to start squeezing monetary policy in the near future. The current thinking is that the Federal Reserve will begin raising interest rates at some point next year. Today’s GDP data certainly doesn’t offer a reason to think otherwise. But as preludes to higher yields go, the recent decline in the market’s inflation forecast is a curious development. It may also turn out to be a troubling development if it rolls on, although the jury’s still out on what the latest fade for predicting inflation means. There are, however, several possibilities to consider.
The first is simply that the slide in expectations of late is noise. This is always a plausible analysis when it comes to reading the real-time tea leaves of asset pricing, at least until we see a substantial change that prevails. It’s too soon to dismiss this possibility, although we’ll know more in a week or so.
