NEW YORK- The bond market is pricing in a sharp deceleration in inflation over the next year, as aggressive tightening by the Federal Reserve to counter the steepest surge in prices in a generation ramps up recession concerns.
The deceleration, which economists also call disinflation, is characterized by a slowing of the rise of overall prices and likely would be a welcome respite for financial markets reeling from inflation’s impact. It is distinct from the more serious deflation, when prices throughout the economy decline overall.
Just look at the falling US breakeven inflation rates, bond market measures of investors’ expectations on the pace of the rise in prices. Breakeven inflation is the difference between the yield on US Treasury Inflation- Protected Securities (TIPS) and nominal Treasuries, and has been lower across the curve, from one-year to 30-year maturities.
“Disinflation would be good for the market because the Fed won’t need to raise rates as much,” said Nancy Davis, founder of Quadratic Capital Management and portfolio manager of the Quadratic Interest Rate Volatility and Inflation Hedge ETF (IVOL).
Fed funds futures on Friday have priced in an additional 187 basis points of cumulative tightening by the end of the year and showed a more than 90 percent chance of another 75-bps interest rate hike later this month following a stronger-than-expected US jobs report for June FEDWATCH. The Fed has raised rates by 150 bps so far this year.
While the US payrolls report eased recession concerns for now, investors kept a close eye on wage growth, which showed a slight O.3 percent decline in June after gaining 0.4 percent the previous month. That lowered the year-on-year increase to 5.1 percent last month from 5.3 percent.
