Conventional wisdom is that markets are the best place to get unbiased forecasts, but we see a sharp divergence of views between what TIPS buyers and Treasury traders in general anticipate inflation rates will be versus consumer expectations and the continued high inflows of new funds into commodities. We’ve seen this sort of divergence before. For instance, last year, the credit markets registered much greater concern about financial institutions and the economy that did the stock market (even after it fell briefly into an official bear market).
TIPS buyers aren’t alone in this view. Merrill Lynch chief North American economist, David Rosenberg, in a recent research note, “Dubunkging five myths” (hat tip Michael Shedlock) argued that the prospects for the economy were far worse than widely depicted. His detailed forecasts show US GDP growth of 1.1% in 2008 to be followed by 0.5% in 2009 (!) and the GDP price increase of 2.7% in 2007 to be followed by 2.1% in 2008 and 1.1% in 2009. He also sees CPI increasing 3.6% in 2008 and 1.5% in 2009.
Treasury bond traders are telling Americans to stop fretting about inflation.
Consumers expect prices to rise 5.2 percent in the next 12 months, according to a monthly survey by the University of Michigan in Ann Arbor….Treasury Inflation Protected Securities, or TIPS, show traders anticipate inflation of about 2.9 percent by January, in line with its average of 3.1 percent the last 20 years.
The disparity has never been wider. ….TIPS say the commodities market is a bubble about to burst. A commodity slump would worsen losses in the $500 billion TIPS market, where investors lost 2.35 percent in April, the most since December 2006.
“There’s a lot of people who just don’t believe the economy’s going to stay strong enough to keep prices of things where they are,” said Chris McReynolds, who trades TIPS in New York at Barclays Plc, the largest dealer of the securities. “Part of what’s going on here is a lot of people view this price rise in oil, a lot of commodities, as being somewhat bubbleish and that they’ll come off again very quickly.”…
“What has not been going up is housing prices, what has not been going up is electronics, what has not been going up is apparel,” said Gang Hu, a TIPS trader at Deutsche Bank AG in New York. Consumers “buy food everyday, they buy gas everyday. As a result, if you ask them have you seen inflation, they will say yeah, because everyday they are informed there is inflation.”….
Consumers are responding to a jump in the cost of food and oil, even as prices of less frequently purchased items like cars, plane tickets and hotel rooms fall…..
The economy won’t grow at all this quarter, marking the worst slowdown since the 2001 recession, according to a Bloomberg News survey of 80 forecasters. Inflation will slow to 2.5 percent by the first quarter of 2009, the least since August, according to a separate poll…
Consumers and TIPS traders both influence Federal Reserve policy makers, who study the two groups’ inflation expectations when making interest-rate decisions, said Brian Sack, a former research manager at the central bank…
The Fed’s decisions are more complicated when the two groups are “giving different signals,” Sack said. “The measures carry more weight when they’re all moving in the same way and telling a similar story.”….
“It’s almost ingrained in the psyche of the market that people think ultimately inflation will recede because the economy’s slowing down,” said George Goncalves, chief Treasury and agency debt strategist in New York at Morgan Stanley…..
“The consumers are more right” than TIPS traders, said James Evans, who manages $4 billion of inflation-linked bonds at Brown Brothers Harriman & Co. in New York. “TIPS breakevens have continuously underestimated inflation.” …
Regular Treasuries are also pointing to a slowdown in price gains. In the last six months, yields on 10-year notes traded below the inflation rate for the first time since 1980. Over the past two decades, yields averaged 2.87 percentage points more than inflation.
The open question is growth rates in emerging economies. The IMF has revised global growth forecasts down each of the last two quarters, and the UN now projects the world’s economic growth rate at 1.8%. Anything below 2% is considered a global recession.
While a US slowdown doesn’t have the impact it once did, there are separate reasons to think that developing markets will cool off, alleviating demand for commodities.