Tuesday, October 7, 2008

Why are inflation expectations falling?

If you expect, say 5% inflation, then the rate at which you will lend money includes an inflation premium as you have to be compensated for lending in current dollars, and getting repaid in inflated dollars.

In fact, one can measure inflation expectations by looking at the difference between the yields on nominal bonds and TIPS (inflation protected) bonds. In the chart above, the green series represents the inflation expectations and it is falling dramatically.

Commodity prices, including oil, are expected to fall, but is that it?

1 comment:

  1. I think the real story is the dramatic decline in yields on 5-year Treasuries--just ibn the past MONTH. Given the apparent fear right now of any debt instruemnts being sold by the private sector, the only place to stash one's cash in in treasuries of one sort or another. And, so

    4-week T-bills are down from 1.6% at the end of August to 0.13% today.

    1-month T-bills, down from 1.63% to 0.15%.

    6-month T-bills, down from 1.92% to 1.12%.

    1-year T-bonds donw from 2.17% to 1.41%.

    2-year: 2.36% to 1.60%.

    3-year: 2.6% to 1.86%

    5-year: 3.10% tp 2.64%

    7-year: 3.45% to 3.09%

    10-year: 3.83% to 3.63%

    20-year: 4.47% to 4.26%

    30-year: 4.43% to 4.11%.

    In general, the shorter the maturity, the greater the (percentage) decline in yield. I read this as a flight from risk, not really as a change in inflation expectations.