Tags: inflation | fed | markets | signal

Inflation Markets Send a Worrying Signal on the Fed's Stance

Inflation Markets Send a Worrying Signal on the Fed's Stance

Thursday, 01 August 2019 01:30 PM

One of the Federal Reserve’s goals for its first rate cut in a decade was to lift the market’s sights on inflation. The initial reactions look not just disappointing for policy makers but near-disastrous.

Market measures of inflation moved higher only briefly following the quarter-point reduction Wednesday, and have been sliding since. The Treasury yield curve has flattened sharply, suggesting traders are worried longer-term growth may be at risk because the Fed’s action -- which Chairman Jerome Powell said wasn’t the start of a prolonged period of easing -- is too modest.

“I think that the Fed has to be pretty worried about the response,” said Eric Patlovich, a fixed-income portfolio manager at New Century Advisors. “It screams policy error where you see the flattening of the curve, you see inflation expectations continuing to come down. That’s just markets telling the Fed they’re going to force its hand into cutting more.”

The 10-year breakeven rate, a gauge of where the market thinks consumer price inflation is headed over the coming decade, has fallen 6.8 basis points from its level just before the Fed’s decision, reaching 1.71%. The Fed has a 2% target for that. The move reverses much of the modest upward trend in the weeks before the Fed’s July 30-31 meeting, when traders entertained the prospect of a larger, half-point cut.

And inflation expectations weren’t the only casualties of an underwhelming policy action, as the yield curve’s rapid flattening suggests an even more pessimistic growth outlook. The gap between two- and 10-year Treasury yields shrank to as little as 12.8 basis points, the tightest since March. The move is led by a rising two-year yield as investors scaled back their positioning for further rate cuts. But the longer-term yield’s simultaneous slide below 2% may reflect concerns that the Fed’s conservative steps won’t prevent an economic downturn.

This pessimism deepened following the release Thursday of U.S. manufacturing data, which showed a surprise drop in activity and prices paid last month.

New Century’s Patlovich says he expects that policy makers will have to take further action before long, whether it’s a cut in September or December. In his view, ultimately, “the Fed decides when to hike and the market decides when to cut.”

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One of the Federal Reserve's goals for its first rate cut in a decade was to lift the market's sights on inflation.
inflation, fed, markets, signal
Thursday, 01 August 2019 01:30 PM
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