Inflation Expectations in TIPS Have Peaked

The U.S. Treasury sells inflation-protected notes and bonds, known by their acronym TIPS. The difference between their yield and the yield on nominal Treasury securities, we can estimate the inflation expectations harbored by TIPS investors. 

The Federal Reserve reports market yields for TIPS with maturities of 5, 7, 10, 20, and 30 years. The average yields for these securities in September were as follows:

1.22 percent on the 5-year;

1.16 percent on the 7-year;

1.12 percent on the 10-year;

1.19 percent on the 20-year; and

1.28 percent on the 30-year.

Using median Treasury auction yields for nominal securities (to avoid influence from short-term yield volatility), we get the following:

4.13 percent for the 5-year;

3.85 percent for the 7-year;

3.24 percent for the 10-year;

3.75 percent for the 20-year; and

3.45 percent for the 30-year.

Simple subtraction gives the inflation expectations among TIPS investors in September:

2.91 percent for the 5-year;

2.69 percent for the 7-year;

2.12 percent for the 10-year;

2.56 percent for the 20-year; and

2.17 percent for the 30-year.

With the caveat that we are comparing TIPS market yields with median auction yields for nominal securities, these inflation numbers are nevertheless telling. They suggest that investors in U.S. sovereign debt expect inflation to remain well above the Federal Reserve's target rate of two percent for several years to come. 

Figure 1 shows how the same inflation expectations have evolved over the past five years. 

Figure 1

Sources of raw data: Federal Reserve (TIPS); U.S. Treasury (Nominal)

There is a silver lining in the rise of inflation expectations since 2020: they have plateaued over the past 12 months, and thus have not incorporated the significantly higher inflation rates in producer and consumer prices. This means that the current inflation rates are widely expected to be relatively short-lived. If the price-setting decision makers of key businesses share the same expectations, there is less risk that current inflation is perpetuated simply by expectations, as is otherwise a problem in countries that suffer from high inflation.