It has taken four decades, but the Federal Reserve has finally shaken the fear of inflation. Markets are only waking up to the implications of change.
The contours of change have been developing for some time, as the Fed’s focus has shifted from its inflation mandate to a constant emphasis on its goal of full employment. Meanwhile, its measure of rising prices has shifted to an average target, which has allowed inflation to exceed a 2% target to offset past shortfalls.
Last week, Fed Chairman Jerome Powell outlined the final two steps: looking at where inflation really lies, rather than worrying about where it is projected to be, and making it clear that not even wild excess current in the stock market nor the recent recession in bond yields bothers him.
The change should lead to a reassessment of the dominant market narrative. So far, it has been assumed that the Fed will tolerate short-term inflation created by President Joe Biden’s $ 1.9 trillion stimulus, but that in the long run the Fed will reaffirm control or inflation will go away on its own. .
In the bond market, this version of the story shows increased inflation expectations over the next five years, a break-even point of 2.51%, although to an extent that usually exceeds the preferred inflation level. for the Fed. Over the next five years, inflation expectations are much lower, just 2.11% on Friday; if correct, it would almost certainly mean that the Fed’s preferred measure of inflation would be below its 2% target.