Professors and writers sometimes make the dreaded mistake of mixing metaphors - trying not to bite the hands that feed us when we have a chip on our shoulders.
The financial markets aren’t using metaphors, but are sending mixed signals. The bond market is once again saying U.S. inflation is on the way up. The commodity markets and current inflation statistics say otherwise.
The U.S. yield curve — a graph of interest rates on U.S. Treasury bonds by their length to maturity - is dramatically steeper since the Federal Reserve announced the start of additional bond purchases. The Fed’s policy is meant to lower yields, hopefully encouraging more investment and consumer spending. These efforts, however, are being offset by investors’ expectations that inflation will be much higher in the long run.
The gap between two-year and 30-year Treasury yields now stands near 4 percentage points, a record. The spread between 10-year and 30-year Treasury yields is now 1.4 percentage points. In normal times, these differences are less than 2 and less than 1, respectively.
The bond market tells us what is likely to happen to prices. The measures of inflation, most frequently read about, are calculating past prices.
Past inflation, as measured by the consumer price index, remains relatively low and stable. The CPI is the most widely followed measure of inflation. The U.S. Bureau of Labor Statistics reported this week that consumer inflation rose 1.2 percent over the last 12 months, compared with a 10-year average change of 2.4 percent. The index shows the cost of a basket of goods and services relative to the cost of the same items in the previous period.
With this measure, the bureau tracks the goods and services a “normal” U.S. household regularly purchases. The index is calculated by holding this basket of goods constant while following price changes for each item. The percentage change in the index thus measures the inflation rate.
The report says that an increase in energy prices was the major inflationary factor. Gasoline prices rose nationally for the fourth month in a row and accounted for almost 90 percent of the increase in the overall index.
Not so here in the West. The CPI for urban consumers in western cities with a population base the size of the Boise Valley rose at an annual rate of only 0.1 percent. Gasoline prices have held steady here for most of the year.
Prices may be rising nationally but not in the financial markets. In the commodity futures market, gold prices are 5 percent lower than their all-time highs earlier this month, and oil prices fell more than 7 percent in just the last two weeks. In the currency market the dollar has risen nearly 3 percent.
Like mixed metaphors, mixed market signals are confusing. Trailing inflation is very low, commodity values are declining, but interest rates are rising.
One possible explanation for the conflicting bond signal is the risk of long-term U.S. government debt. Investors are happily purchasing short-term bonds, keeping the interest rate low, but are concerned with the long-run risk of default on Federal government debt.
When looking for bonds with no risk of default, there are few if any alternatives in the world to U.S. Treasury bonds. The bond market is saying this may be changing.
Yes, inflation is low now, but as metaphors go, “it will come back to bite us if we rest on our laurels.”
Peter R. Crabb is a professor of finance and economics at Northwest Nazarene University in Nampa. He earned his doctorate in international and financial economics from the University of Oregon.