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–JP

Mr. Market has been wearing optimism on his sleeve when it comes to estimating the future path of inflation by way of the spread between nominal and inflation-indexed Treasuries with 10-year maturities. But the optimism that has been fashionable this season past may fall out of favor this summer as inflation fears heat up.
As of last week’s close, the nominal yield on a 10-year Treasury was 5.06%, according to the databank maintained by the U.S. Treasury. The 10-year inflation-indexed Treasury (or 10-year TIPS, as everyone likes to call them) ended the week at 2.44%. The spread between the two was 2.62% (5.06 less 2.44). In other words, Mr. Market’s forecast of inflation is 2.62%, as the chart below illustrates.

How high is 2.62% as an inflation forecast? Arguably, not high enough, even though it represents the upper range based on the last three years, and up about 30 basis points from 2005’s close. But on one level, at least, 2.62% as an inflation expectation appears more than a little dovish. We come to the conclusion by pointing out that 2.62% is considerably below the 3.5% current annual pace of increase in consumer prices.

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