Inflation expectations rise modestly on expected stimulus

NEW YORK (Reuters) – U.S. inflation expectations rose on Wednesday in anticipation of more fiscal stimulus after Democrats secured control of the Senate.

With control over both legislative houses now secured, Democrats have more power to advance President-elect Joe Biden’s agenda.

New York Senator Chuck Schumer on Wednesday said sending most Americans $2,000 checks would be a top priority in the new Congress. Still, with the Senate divided down the middle, compromise with Republicans and rightward-leaning Democrats will be necessary for Biden to make substantial changes.

The breakeven inflation rate on the 10-year Treasury Inflation Protection Security (TIPS) – which is typically in line with market expectations of inflation – rose to an intra-day high of 2.092%.

It was last at 2.069%, ending the day at its highest level in more than two years. But the rate was nevertheless just a hair over the Federal Reserve’s target average 2% rate and only slightly larger than moves higher on Monday and Tuesday.

The move in inflation expectations came as the benchmark 10-year Treasury yield broke through 1%, out of recent trading ranges, to its highest since March.

“Markets are certainly now expecting significantly more fiscal boost than was assumed yesterday. At least for today, it seems that’s only having a minor impact on inflation and a more substantial impact on real growth expectations,” said Tom Graff, head of fixed income at Brown Advisory.

Further stimulus would require the U.S. to add to the $1.8 trillion in new debt JPMorgan estimates the Treasury already needed to issue in 2021.

The prospect of additional supply drove investors into inflation hedges, sending the U.S. 10-year TIPS yield to its highest since Dec. 16.

There was skepticism about how long it would take for U.S. prices to rise meaningfully. Inflation has remained stubbornly low for much of the past decade, and market participants have bet that tax cuts, rate cuts, elections, trade wars and more would lift prices in the United States.

“While we expect inflation to rise in the longer-term, in the short-term there is still a decent-sized output gap,” said Eric Winograd, senior economist for fixed income at Alliance Bernstein.

“There are still a lot of people out of work. It’s going to take some time. That may be why inflation expectations have been slow to respond.”

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