The FOMC minutes were not very surprising. The FOMC is not in any hurry to raise interest rates before the middle of next year at the earliest.   The FOMC statement did not drop the “considerable period” phraseology to describe the time between the end of QE and the first rate hike. However, the minutes show it was a point of discussion and a compromise was achieved to emphasis the data dependency of the Fed’s actions.  

In speeches by many Fed officials it is evident that the decline in inflation expectations is a issue of concern. The minutes revealed that some officials were more concerned about a further breakdown in long-term inflation expectations than they were about growth faltering.  

The recent University of Michigan’s survey showed the long-term (5-10 year) inflation expectation has slipped to 2.6% from 2.8%. This is the lowest since March 2009. Breakeven rates, which compare the inflation-protected securities to the conventional bond yields have deteriorated more than the survey results. The 10-year breakeven was near 2.3% at the start of H2, and is now near 1.84%, just above the mid-October spike low (1.83%).  The 5-year breakeven was near 2.1% in early July and fell to 1.4% in the mid-October swoon. It is now 1.50%.  

Another market-based measure of inflation expectations is the 5-year/5-year forward. It as near 2.60% at the end of H1 and is now near 2.17%, which represents a new low for the year. Both last year and in 2011, there were spikes to 2.0%.  

The different metrics produce different results, but they are all moving in the same direction. The drop in energy prices, including gasoline, is significant for households and businesses. Inflation expectations are about the headline rate. For policy purposes, the Fed gives a privileged place to core price, which excludes food and energy. The reason is not that the officials are trying to be deceptive, but because for the last half century or so, headline inflation converges to core inflation, not the other way around. That is to say, the core rate offers a stronger signal than the volatile headline rate, which is important for other matters, like cost-of-living adjustments. The inflation-protected securities are linked to headline CPI.