HAS INFLATIONARY EXPECTATIONS INCREASED?

As mentioned many times, inflation is a two part dimension…too much money chasing too few goods fearing higher prices tomorrow.  It has a monetary and psychological component.

The Fed is adamant to crush inflation at the expense of the economy.  The Fed also does not want inflationary expectations to become unanchored as was the case forty years ago.

In the early 1980s the FOMC publicly expressed its frustration that long term interest rates rose by 50% while inflation fell by 50%.  Economic historians now claim the primary reason for this disconnect was inflationary expectations.

Fast forward to today.  Inflationary expectations are well anchored as evidenced by the yields on longer dated Treasuries.  Historically longer dated debt trades 200-300 bps over the prevailing inflation rate.

Today the inflation rate is 7.7% yet longer dated Treasuries are trading around 4.0%.  The market has complete confidence in the Central Bank, believing inflation will decline to 2.0%.

Is this realistic?

Friday the University of Michigan’s Sentiment Survey indicated that consumer’s inflation rose both in the short and long run.  Consumers expect prices will rise at an annual rate of 3.0% over the next five to ten years, up from 2.9% in October and the highest in five months.

Consumers also expect costs to rise by 5.1% over the next year compared to last month’s 5.0% rate.

Last week’s enormous rally in both the Treasury and equity markets is viewed with skepticism with many believing it was the result of momentum-based technology driven trading.  Numerous Fed officials have cautioned inflation is still too high and the only tenant that may have changed is the rate of interest rate increases, dogmatically stating the Fed is nowhere near a proverbial pivot.

Will the advance be reversed?

What will happen his week?

The economic calendar is comprised of several manufacturing indices, the PPI, retail sales, import/export prices, numerus housing statistics and a sentiment survey.  How will the data influence outlooks?

Last night the foreign markets were up.  London was up 0.25%, Paris up 0.27% and Frankfurt up 0.36%.  China down 0.25%, was Japan down 1.06%  and Hang Seng up 1.70%.

Dow and NASADQ futures are off 0.25% and 0.75%, respectively, as markets are overbought following last week’s strong advance that many are questioning its sustainability. The 10-year is off 22/32 to yield 3.91%.

 

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