Magazine article Economic Trends

New Fed Policies and Market-Based Inflation Expectations

Magazine article Economic Trends

New Fed Policies and Market-Based Inflation Expectations

Article excerpt

10.09.2012

by Mehmet Pasaogullari and Patricia Waiwood

Market-based measures of inflation expectations reflect what investors anticipate inflation will be in the future. These measures rose in the days after September 13, when the Federal Reserve announced a third round of large-scale asset purchases and decided to keep the target range for the federal funds rate at an exceptionally low level at least through mid-2015. This round of asset purchases, unlike its predecessors, is open-ended, meaning it will continue until the outlook for the labor market improves substantially.

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Immediately after the announcement, speculation arose that the new policies would push inflation higher than the target rate. Yet between then and now, market measures of inflation expectations have fallen considerably. This change suggests that market participants are now not expecting the new policies to boost inflation across any time horizon.

The spike in inflation expectations in the days surrounding the September announcement shows up in measures that are based on a range of short-term and long-term rates of different maturities. The peak occurs almost invariably either on the day of the announcement or on the day following it, as the rightmost vertical markers in the charts below show.

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Some rates--more specifically, some forward rates--buck the trend by hitting their respective peaks just a handful of days later. Forward rates focus on a period between one point in the future and another point even farther in the future. Their appeal to analysts is that they give a view of future inflation that abstracts from current short-term shocks. For example, the 10-year, 10-year forward inflation swap rate was 3.3 percent on September 14. This means that on that day, market participants expected inflation to average 3. …

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