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The Uncertain Future of Inflation

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The Uncertain Future of Inflation

January 5, 2021

inflation-expectations

The 10-year breakeven inflation rate returned to its 2018 level this week. The 10-year breakeven is the difference between the 10-year nominal and 10-year inflation-linked bond, it is a measure of what the market thinks inflation will be in several years. The higher rate could mean people may think inflation will return soon. The odds are it will, there will probably be a vigorous recovery as the pandemic subsides and the Fed has promised to keep monetary policy loose for the foreseeable future. Strong growth and easy money caused inflation in the past. But gains in productivity or more trade could dampen inflation. Economists argue that inflation expectations tend to be self-fulfilling. So if the market sees inflation picking up, it could be true. 

However, the breakeven rate includes both inflation expectations and the inflation risk premium. The inflation risk premium is how much investors want to be compensated for bearing inflation risk. The breakeven increase could be higher inflation expectations or a feeling that the inflation environment is about to get a lot more uncertain. It is impossible to know. 

Either way, inflation doves should take notice. 

Allison Schrager is a senior fellow at the Manhattan Institute. Follow her on Twitter here.

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