Quick TIPS

For those of you who like to use the TIPS spread as an indicator of inflation expectations:

[Click image to enlarge]

The average is tracked by the 10 year spread almost perfectly. I personally view 2.25% annual inflation expectations as too low relative to the needs of the economy (to get back to our previous trend NGDP growth path), but it’s certainly better than .12%.

Also, as you may have heard, interest rates on long-term nominal bonds have spiked recently. This means that the “real” or “Wicksellian natural” interest rate is rising, which is a good sign for recovery. Given a couple more months of positive indicators, and even the bearish-est of bears will have to admit a trend!

Also, here you can see that excess reserves are slowly declining, another positive sign! However, if the Fed uses the interest rate paid on excess reserves as the instrument of monetary policy going forward, the equilibrium level of reserves remains unknown as of right now.

[Click image to enlarge]

Addendum: In the “related links” second, you’ll see a headline that says TIPS indicate 3% trend inflation, which is blatantly at odds with my 2.25%. To shed some light on this, here is the rationale behind the 3% is calculation:

A better reading can come from the “5yr5yr breakeven,” which uses implied inflation rates on five-year and 10-year TIPS to calculate inflation expectations in the period five to 10 years down the road.

There are different ways to calculate the 5yr5yr breakeven, but according to a version published by the Fed, inflation is expected to exceed 3% per year. That figure has been stable for several months. However, it’s also at levels last regularly seen in 2003 and 2004, when many say the Fed helped inflate the housing bubble.

I’m guessing Barclays uses this, but I’m not sure of the specifics…I’m perfectly happy with simple subtraction.


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