Wednesday, June 6, 2012

Oh Boy, Get Ready for Krugman to Warn about Deflation, Again

The US inflation indexed treasury curve (TIPS curve) has inverted sharply in the short end. The one-year TIPS yield went from negative 2.5% to zero in a matter of four months. The one-year treasury (nominal) yield on the other hand has held fairly steady near zero (between 12bp and 20bp over the past 4 months). That means that the market is now pricing near zero percent inflation over the next year (down from over 2.6% expected just 4 months ago!) - as near-term inflation expectations collapse, reports Sober Look.

SL then gives the Krugman deflationist view on what this means:
...this move in TIPS certainly raises the risk of near-term deflation, driven by weak demand growth. And deflation is notoriously difficult to get under control. This feels (though only in the near term) a bit like Japan, a nation quite familiar with zero to negative inflation expectations.
So prepare for Krugman to be worrying about deflation once again. And he will be using this TIPS data to make his point. However, as I have pointed out before, TIPS is a very complex instrument, that does not necessarily  reflect simple price inflation expectations.

Given the current hot money flows into the United States from the eurozone, this could simply be hot money chasing yield in a currency (the dollar) that they expect to out perform their currency (the euro). But bottom line, if you don't know the algorithmins of those buying the TIPS, its difficult to say what TIPS is saying about future price inflation---but I don't think this will stop Krugman from warning about deflation again.


  1. I thought it was agreed by all that the Fed has effectively destroyed the significance of the yield curve with QE? Wouldn't talk of more QE lead exactly to an inverted curve, especially if the Fed is pushing down yields on the mid to long end?

  2. Deflation is to Keynesians what Moby Dick was to Captain Ahab. The fear of it is irrational and all consuming. They will destroy our currency and our national economy just to save us from a money with more purchasing power! They are insane.

    Mr. Wenzel, love your website but I really wish you would use a spell checker. Also, maybe you could include Disqus ID's for comment identification.