Traders align with Fed on inflation as rate-hike bets intensify

(Bloomberg Business) — After chiding the Federal Reserve earlier this year for having overly bullish inflation expectations, the Treasury market is starting to concede that consumer prices are set to move higher.

Traders are gravitating toward Fed Chair Janet Yellen’s stance that the rout in oil prices will fade, inflation will tick up and the U.S. economy will be able to withstand the first increase in interest rates in almost a decade.

A measure of traders’ expectations for inflation beginning in 2020 has held above the Fed’s 2 percent target since April. The central bank targets the level as part of its mandate to balance price stability with fostering economic growth to achieve full employment. The five-year, five-year forward break- even rate, at 2.14 percent as of July 13, is just off its 2015 high.

“They are coming around partly to the Fed’s point of view,” Jim Vogel, head of interest-rate strategy at FTN Financial in Memphis, Tennessee, said by phone. “Traders now recognize that inflation has a great deal more potential in a couple of years than they did earlier this year.”

Traders admonished the Fed earlier this year for its view that the rate of price increases would pick up. Inflation expectations based on the break-even rate fell to 1.75 percent on Jan. 30, the lowest since 1999. Now, as sentiments align, the market is growing more confident that the central bank is better positioned to move forward with increasing its benchmark rate, which has been near zero since 2008.

 “The market has no longer priced in the doomsday scenario,” Stanley Sun, a New York-based strategist at Nomura Holdings Inc., one of 22 primary dealers that trade with the Fed, said by phone. “The market overshot toward the downside.”

Price Measures