The US two-year breakeven rate, which is the implied forward spread between treasuries and TIPS, has quietly risen above 2%. This is a measure often used as a market-implied inflation expectation indicator. Normally such an increase would not be a big deal, except that the Fed is now targeting 2% inflation rate. The market however is pricing inflation expectations above that level within the next two years.
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| US Breakeven 2 Year (Bloomberg) |
The Fed Funds Futures have responded accordingly, implying overnight rates of around 50bp (two rate increases) at the 2.5-year point (30 months out). The market has basically discounted the Fed's announcement that rates will stay at zero for a longer period. The rate implied by the Fed Funds futures 2.5 years out has risen above the pre-Fed announcement levels.
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| Fed Funds Futures implied rate 30 months out (Bloomberg) |
This should make Bernanke happy because deflationary pressures have largely been alleviated (for now) while significant additional quantitative easing is now more difficult to justify.
SoberLook.com
