According to the US bond market, inflation expectations have stalled over the past six months. The five-year inflation rate is around 2.5% and the 30-year inflation rate is about 2.25%. We derive these rates from the published nominal bond yields and combining them with the rates for Inflation protected bonds.
The first thing to note is that the 5-year rate is higher than the 30-year rate, so the term structure of inflation suggests that inflation will fall over time.
Of note also is that the run up of implied inflation, between March 2020 and August 2020, coincided with the run up in the gold price to around $2,050 per ounce.
As inflation expectations have tempered so has the price of gold, showing a trend line decline since August 2020 to the current price of $1,760 per ounce. Gold needs relatively low nominal interest rates and high inflation expectations.
According to most of the mainstream media, the current transitory inflation will morph into long term inflation. Pundits have been invoking the famous phrase of the economist, Milton Friedman: “Inflation is always and everywhere a monetary phenomenon in the sense that it is and can be produced only by a more rapid increase in the quantity of money than in output.” Think of the world’s deficit spending, with the European and the US quantitative easing, and you would be convinced that German Weimar Republic hyperinflation is on the way.
Except the biggest and most liquid bond market in the world says it isn’t.
The invocation of Milton Friedman statement, “Inflation is always and everywhere a monetary phenomenon” requires that the velocity of money should be stable. Except, in our modern monetary world, the velocity of money has been declining.
What about quantitative easing (QE) – shouldn’t that be inflationary. QE is an example of the old two card monte trick. I can’t tell how many experts tell us that QE is liquidity sitting on the Banks’ balance sheets, ready to be lent out and able to cause inflation. Except QE sits on bank balance sheets as reserves and can’t be lent out – something the Federal Reserve acknowledges.
What about deficit spending? Peak deficit spending has past, and the Morrison Government is certainly committed to cutting back the programmes. The US is currently having great difficulty getting the $3.5 Trillion deficit package through, with only $1.5 Trillion currently on offer.
On balance, the US bond market is saying that the current bout of price inflation is transitory, and the evidence suggests they are right.
