Great Graphic: Inflation Expectations Rising

The June light crude oil futures contract has rallied by nearly a third since the middle of March.  More broadly, the CRB Index has appreciated by 12% in the same period.  There have been some signs, albeit minor and preliminary, that labor costs are rising in the US, Japan and Germany. 

The threat of deflation has ebbed and inflation expectations are rising.  This is not the cry heard from some observers since the Great Financial Crisis that the easing of monetary policy will generate hyper-inflation.

The point here is to be sensitive to changes in inflation expectations.  One market-based way to measure inflation expectations is to subtract the yield implied in inflation protected securities from the conventional yield.  This is the break-even rate, or the rate of inflation that is necessary to reward one for buying an inflation protected security. 

This Great Graphic shows the 10-year break-evens for three countries.  The US is the white line.  The break-even bottomed in January near 1.53%.  In mid-March it was near 1.65%.  Now it is near 1.95%. 

Germany is the yellow line.  In early January, the German 10-year break-even dipped below 0.60%.  By mid-March, it had doubled to 1.20%.  It is now near 1.30%.  

Japan's 10-year break-even is depicted by the green line.  It has risen from about 0.70% in mid-January.  It moved above 1.0% in March and is now trying to push through 1.10%. 

There is an important caveat:  direction matters.  As government bonds rallied, the break-even fell. As government bonds sell off, the break-even rates rise.  This may partly be a function of liquidity.  Many officials, including the Federal Reserve had played down the decline in inflation expectations on market-based measures.  The Fed seemed to give greater weight to surveys results.  

However, the University of Michigan's survey of long-term (5-10 years) inflation expectations show a mild relaxation this year.   The survey results have fallen from 2.8% to 2.6%, which matches the cyclical low.    

Separately, we note that while US and German 10-year conventional yields have risen 32-34 bp over the past month, Japanese 10-year yields are flat.   This suggests that, at least in Japan's case the market direction does not account for the rise in Japan's break-evens.