Every month with the release CPI release I do an ‘inflation day post’. This month I missed out on the coverage of the Cleveland Fed inflation expectations curve, but better late than never!
The charts show that inflation expectations year after year have been going down for all maturities. That remains true comparing last month´s to this month´s curve. I would have thought that the greater optimism that lately has pervaded comments and analysis and that is reflected in stock market behavior, for example, would have ‘bumped up’ inflation expectations. Apparently not.
So I decided to compare the Cleveland Fed inflation expectations (5 & 10 years) to the 5 and 10 year TIPS spread. This is what transpired.
The TIPS spread measure of inflation expectations is much more ‘sensitive’ than the Cleveland Fed´s calculation, but what I was looking for is to see if they tell the same ‘story’. Note that they both go up after QE0 at the end of 2008, when it became clear that the Fed would not let the financial system ‘go broke’. In March 09 QE1 is implemented and both measures of expectations, for the medium and long term, keep going up. They reverse trend when QE1 ends in March 10. They react positively to hints of QE2 in late August 10 but come down again after April 11 when the Fed confirmed the end of QE2 scheduled for June 11.
The divergence between the two measures of inflation expectations follows the launch of ‘Operation Twist’ in September 2011. While long term inflation expectations derived from the TIPS spread go on a rising trend that remains even now, following QE3 in September 12 (and QE3 cum thresholds in November) 10 year inflation expectations from the Cleveland Fed remain ‘flat’ and then notch down a step last May.
The divergence is not so great for the medium term measure of inflation expectations, but it is still visible in the data.
Operation Twist´s purpose was to affect the term structure of rates, hopefully lowering longer term rates. Maybe the divergence reflects technical aspects of the Cleveland Fed measure impacted by the policy. For those with a technical bent the Cleveland Fed methodology is described here.
Or maybe it´s something else. Any ideas?