Friday, February 24, 2012

Promises, promises

As we know, the Fed has announced an inflation ceiling of 2% AND that it will keep short term rates close to zero at least until the later part of 2014.

I believe these two commitments are contradictory if we manage to achieve a decent economic recovery, and it is looking more and more like we are finally getting exactly that.

Here is a chart of the implied 2 year ahead level of inflation expectations derived using yields on inflation protected securities (TIPS):

The red line is the Fed's 2% ceiling.

People, can I get a YIKES?

The source for this chart is here, the hat tip goes to LeBron, and the source also argues that markets are strongly pricing in a Fed rate increase in 2013.

At this point, unless the recovery falters, I don't think the Fed will keep EITHER of its two promises


kebko said...

The forward fed funds rate could just reflect stochastic noise, given the zero bound. I don't think it necessarily reflects an increase in the mean expected rate. If the rate does rise, it is not likely to rise just 25 or 50 basis points. I agree with you that the story given by the fed is unlikely to hold.

John Thacker said...

I think some people view the 2% as a target, not a ceiling, in which case the Fed is too low right now and 2013 will actually mark success.

Anonymous said...

Rate hike in 2013? Shades of Nordhaus!