Defying the best efforts of central banks over the last nine years, inflation has yet to rear its head. Although many would welcome inflation growth above 2%, the markets are flashing warning signs that a return to pre-crisis levels might not produce the expected results. Instead, such an increase could bring volatility, which is often a code word for falling markets.
On Jan. 25, 2012, the Federal Reserve aimed for 2% core personal consumption expenditures as a desired level of inflation. As the chart below shows, inflation has mostly remained well below this target. That was bad timing on the Fed’s part.
The Fed’s inability to create inflation has flummoxed Chair Janet Yellen, who led the last meeting of her tenure on Wednesday. As the following two citations show, the “data-dependent” Fed chief was reduced to the words “guess,” “expect” and “believe.”
On Oct. 15, 2017, she said:
My best guess is that these soft readings will not persist, and with the ongoing strengthening of labor markets, I expect inflation to move higher next year.
And on Dec. 13, 2017, she said:
I’ve talked in detail about this in the past and recognized that there is uncertainty about what’s holding inflation down, but my colleagues and I continue to believe that the factors that are responsible this year for holding inflation down are likely to prove transitory.
The markets have also struggled to forecast inflation correctly. The chart below shows the U.S. 10-year inflation breakeven rate, or the market’s expectation for the average inflation rate over the next 10 years. Between 2010 and 2013 the market regularly thought inflation was returning, but it never did. A year ago, it also thought so, but that didn’t happen, either. And the market thinks inflation is returning now.