The hard data on inflation points to a modestly accelerating rate of inflation, a trend that supports the Federal Reserve’s ongoing policy of gently but consistently raising interest rates. The main push-back to that narrative is the Treasury market.

On two fronts, Treasuries are pricing in expectations that the recent rise in inflation has peaked (or at least will remain more or less stable at current levels). One source for this view is the lower spread for nominal less inflation-indexed Treasury yields, widely seen as the market’s implied inflation forecast. The softer outlook on pricing pressure is pronounced for the 5-year maturities: the yield difference has fallen below 2.0% recently after reaching as high as 2.16% in the spring.

Meanwhile, the yield curve has been flattening this year, another trend that some analysts see as a sign that inflationary pressure is waning. St. Louis Fed President James Bullard subscribes to this theory, as he said in a speech this week. “The flattening yield curve and subdued market-based inflation expectations suggest that the current monetary policy stance is already neutral or possibly somewhat restrictive.” He recommended that

US monetary policymakers should put more weight than usual on financial market signals in the current macroeconomic environment due to the breakdown of the empirical Phillips curve. Handled properly, current financial market information can provide the basis for a better forward-looking monetary policy strategy.

To the extent that Bullard’s analysis is accurate, the narrowing yield curve also appears to be signaling that inflation has peaked. Indeed, two widely measures of the yield curve – the spreads on the 10-year and 2-year Treasury yields and the 10-year and 3-month rates – have fallen to post-recession lows recently. If and when the spreads go negative, the slide would be seen as a recession warning, which in turn implies a disinflationary (and perhaps deflationary) environment.