Wednesday, June 15, 2011

Inflation Outlook Has Treasury Bulls Snorting

Inflation Outlook Has Treasury Bulls Snorting

On Wednesday, the consumer-price index is expected to show a gain of 3.3% last month over May 2010. While that is below the 5.6% rate seen in mid-2008, inflation may well be headed over 4% in the months ahead as the earlier spike in commodity prices works its way through to store shelves. Reflecting this, the producer-price index for May, out Tuesday, rose 7% from a year earlier, the most since 2008.
While the bond market has grown jittery this week, it still isn't ringing alarm bells. The yield on the 10-year Treasury note, which moves inversely to its price, has dropped from a high of nearly 3.8% in February to 3.09% Tuesday. So investors have become less concerned about inflation, not more so. Indeed, the market's implied view of annual inflation over the next decade has fallen to about 2.2% from over 2.6% in March, according to Capital Economics, based on the break-even spread between nominal and inflation-adjusted 10-year Treasury yields.

There is good reason for this. Investors sense that inflation gauges look set to peak and start rolling over by early next year. Certainly, a rebound in oil and other commodity prices could draw out that process. But with global growth throttling back, that prospect has dimmed.

Prices on goods further back in the production pipeline, for example, already are down sharply. Prices for finished wholesale goods rose just 0.2% month on month during May, and crude-material prices slumped 4.1%. "The idea that there is significant inflationary pressure in the U.S. economy over the medium term is looking challenged," says BTIG chief global economist Dan Greenhaus.
This also may explain why investors are sanguine about a move upward in the core inflation rate watched so closely by the Federal Reserve. This gauge, which strips out food and energy prices, is seen rising from 1.3% year on year as of April to roughly 2% by year-end. Yet with unemployment stuck at about 9% and growth disappointingly slow in 2011, the Fed seems in no hurry to tighten monetary policy or raise interest rates.
For now, it will take much stronger economic data to get Treasury bulls, and the Fed, excited about inflation.
Write to Kelly Evans at

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