The US stock market continued to climb out of a hole yesterday. The S&P 500 closed at its highest level so far this year. Yesterday’s rise comes a day after the Federal Reserve decided to hold off on rate hikes, citing increased macro risks–here and abroad. But if equities are reacting positively to revived expectations for keeping interest rates lower for longer, is the commensurate rise in the Treasury market’s inflation forecast a potential spoiler for the newly minted party in the stock market?
The Treasury market’s 10-year inflation estimate—based on the 10-year nominal yield less its inflation-indexed counterpart—is holding near a three-month high of 1.57% (as of Mar. 17) via daily data from Treasury.gov. The implied inflation forecast via the 5-year maturities is even firmer, ticking up to 1.46% yesterday—the highest since last summer.
It’s no surprise that the market’s pricing in higher inflation expectations… again. Earlier this week the government reported that core consumer inflation—prices excluding energy and food—inched up to a 2.31% annual pace in February, marking the highest increase in nearly eight years (blue line in chart below). Headline inflation is still weak, running at around 1% on a year-over-year basis (red line). But if core CPI’s track record as a relatively reliable predictor of headline inflation holds up, pricing pressures are set to trend even higher in the months ahead.
“There’s absolutely no denying that there are inflationary pressures,” Tom Porcelli, chief U.S. economist at RBC Capital Markets, told Bloomberg on Wednesday—the day before the central bank’s monetary announcement. “The Fed can no longer be dismissive on inflation. They’re going to have to raise their inflation forecast.”
Perhaps, but the outlook for inflation in Thursday’s updated macro outlook from the Fed revealed a slightly lower forecast for personal consumption expenditures (PCE) inflation on a headline basis for this year and in 2017. For instance, the median forecast for headline PCE inflation is on track to rise 1.2% in 2016, down from the December’s 1.6% estimate.
