Recent Trends and Implications of Short-term and Long-term US Inflation Expectations

1. Inflation Expectations

Inflation expectations play a crucial role in understanding the current economic situation and predicting future economic directions. They are particularly important in central banks' monetary policy decisions and significantly influence financial market participants' investment decisions. Inflation expectations have become a key element in modern economic analysis and financial market investment strategy formulation. Numerous academic studies in finance consistently show that inflation expectations are an important factor in predicting US Treasury yields. This goes beyond mere academic interest and directly affects the investment decisions of financial market participants. These academic findings suggest that bond market investors should consider inflation expectations as a major factor when constructing portfolios and developing risk management strategies.

Furthermore, inflation expectations influence the pricing of various asset classes beyond the US Treasury market, including stocks, foreign exchange, and commodities. For example, high inflation expectations can increase preference for real assets and decrease the attractiveness of nominal fixed-income assets. This directly affects investors' asset allocation decisions.

Inflation expectations are also an important consideration in central banks' monetary policy decision-making processes. Major central banks, including the Federal Reserve, consider the stabilization of inflation expectations as one of their main monetary policy objectives, which in turn affects overall financial market movements.

In this context, this article will examine the characteristics and recent trends of major short-term and long-term inflation expectation indicators and analyze their implications for financial markets and economic outlook.

2. Analysis of Long-term Inflation Expectation Indicators

(Data Source: FRED, Federal Reserve Bank of St. Louis)

The main indicators for measuring long-term inflation expectations are the 5Y5Y Forward Rate, 10Y Breakeven Inflation Rate, and Cleveland Fed's 10-Year Expected Inflation. Let's examine the characteristics and recent trends of each indicator.

a) 5-Year, 5-Year Forward Inflation Expectation Rate (T5YIFR)

• Definition: Average inflation expectation for the five years starting five years from now

• Characteristics: Measures long-term inflation expectations and is useful for assessing monetary policy credibility

• Recent trend: Started at about 1.5% in early 2020, rose to over 2.5% in mid-2022, and has recently stabilized around 2.4%

b) 10-Year Breakeven Inflation Rate (T10YIE)

• Definition: The difference between the yield of a 10-year nominal Treasury bond and a Treasury Inflation-Protected Security (TIPS)

• Characteristics: A market-based indicator that reflects investors' inflation expectations in real-time

• Recent trend: After a sharp drop in early 2020, it quickly rebounded to near 3% in early 2022, then fell to the current level of 2.07%

c) Cleveland Fed's 10-Year Expected Inflation (EXPINF10YR)

• Definition: Cleveland Fed's 10-year inflation forecast combining multiple data sources

• Characteristics: Comprehensively considers market data, surveys, and historical inflation data

• Recent trend: Steadily rose from about 1.5% in early 2020 to near 2.5% in mid-2022, and has recently stabilized around 2.2%

All three indicators showed an upward trend after 2020 and have recently stabilized in the 2-2.5% range. This reflects the market's expectation that inflation will be maintained near the Fed's target of 2% in the long term.

3. Short-term Inflation Expectations: University of Michigan 1-Year Expectation Indicator

The University of Michigan's 1-year inflation expectation survey represents general consumers' short-term inflation outlook.

• Characteristics: Has a significant impact on consumer behavior and short-term economic outlook

• Recent trend: Rose sharply from early 2021 to near 5.5% in mid-2022, then fell to the current level of about 3%

Short-term expectations are much more volatile than long-term expectations. This is because consumers are more sensitive to current economic conditions and short-term factors. The recent downward trend reflects the perception that inflationary pressures are easing.

4. Financial Market Outlook

Bond Market: The current stabilization of long-term inflation expectations in the 2-2.5% range could be positive for long-term Treasury investments. Stable inflation expectations reduce the risk of sharp rises in nominal interest rates, and as the Fed cuts its benchmark rate, Treasury yields are expected to follow suit, potentially leading to medium to long-term increases in bond prices. Moreover, stable inflation expectations can help companies establish financial plans, potentially lowering overall credit risk. This could lead to a narrowing of corporate bond spreads.

Gold: Gold, traditionally viewed as an inflation hedge, is currently setting record highs, but its investment attractiveness may decrease somewhat under stable inflation expectations. However, it still maintains its role as a safe-haven asset against geopolitical risks or economic uncertainties.

Real Estate and Infrastructure: A stable inflation environment can be favorable for real estate investments. The real value of rental income is preserved while the risk of sharp interest rate increases is limited. Also, the stabilization of long-term inflation expectations makes it easier to predict the profitability of long-term infrastructure projects, potentially promoting investment in this area.

5. Conclusion

The current stable long-term inflation expectations generally provide a favorable environment for risk assets. However, investors should still make investment decisions considering various factors comprehensively, including short-term inflation volatility, geopolitical risks, and changes in monetary policy.