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What does the bond market know about inflation?

Inflation is everywhere. Chinese manufacturing price, Wide range of products With price Consumer prices Goods from fruits to freezers are on the rise. Everywhere, that is, except in the bond market.

The five-year inflation breakeven (the difference between a regular five-year government bond yield and an inflation protection yield) is about the same as it was three months ago. In fact, the inflation debate has declined in the most enthusiastic past month.

Nor is it particularly high by historical standards. At an annual rate of about 2.47% over the next five years, inflation currently priced in bond markets has been above historical levels for most of the low inflation period following the 2008 financial crisis. However, from 2004 to 2007, inflation rarely surged, but at a fairly normal level.

Nordea analysts point out that bond yields deviate significantly from their general relationship with inflation over the last 35 years. The core consumer price index of 3.8%, the level reported Thursday, has never been recorded since 1985, alongside 10-year bond yields of less than 6%. This shows investors’ fairly overwhelming belief that inflation is temporary.

How good is the bond market in predicting inflation? Joseph Gagneon, senior fellow at the Peterson Institute for International Economics, said much of the data used was before the existence of inflation-indexed bonds, but yields were It suggests that it correlates much more closely with past inflation than with future inflation.

But with that in mind, investors are making important bets. Bonds will lose value if the normal historic relationship between inflation and yields resumes. In the Treasury market. Fed’s activities have had a major impact, but the central bank owns only about 25% of the total. Most are in the hands of investors who can lose money in a plunge.

Another prediction is mixed bags. Headline inflation averaged 2.4% over the next five years and 2.3% over the next decade, with market prices very high, according to the latest survey by a Philadelphia Federal Reserve expert forecaster released in May. It matches. This week, the University of Chicago Booth School of Business also released a survey of economic experts on the risks of overheating and inflation.Rather than a strong position

Investors who predict the negative effects of inflation remain in the minority of the market, even if the signal from the bond market is incomplete. Pricing is currently almost exactly what the Federal Reserve requires. Given that 1970s-style inflation is actually within expectations, those who haven’t properly placed their portfolios can rest assured that at least most of their peers aren’t doing that.

Write to Mike Bird Mike.Bird@wsj.com

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What does the bond market know about inflation?

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