This installment comes courtesy of former Federal Reserve Governor Lawrence Meyer's Macroeconomic Advisors, in MA's most recent inflation newsletter (subscription required for all that follows):
Breakeven inflation rates have moved up sharply this year, particularly at shorter maturities. The two-year BEI rate, for example, has risen about 100 basis points on net since its trough in November. A sizable portion of that increase is attributable to higher expected energy prices. However, that is not the whole story, as our ex-energy measure of the two-year BEI rate has increased about 50 basis points over that interval.
A bit of background. Breakeven inflation rates are variants of the adjusted TIPS-derived inflation expectations calculated by the Cleveland Fed (discussed yesterday). Explains MA:
Breakeven inflation rates provide a signal about the market’s outlook for inflation and its concerns about inflation risk. Specifically, the BEI rate at a certain maturity is equal to the expected CPI inflation rate over that horizon plus an inflation risk premium (the expected excess return that investors demand for holding the nominal security).
And:
Breakeven inflation rates can be substantially affected by actual and expected movements in energy prices, reflecting the fact that TIPS are indexed to headline CPI. These effects are particularly pronounced at shorter maturities. In this commentary, we use oil futures prices to estimate the contribution of energy prices to breakeven inflation rates. By adjusting for this contribution, we can compute measures of ex-energy breakeven inflation rates. These measures allow for a better interpretation of the market’s perceptions of inflation pressures and for a better assessment of whether TIPS valuations are appropriate.
Returning to the latest analysis, then:
This [year's] increase in ex-energy BEI has presumably been driven by a string of unfavorable inflation news, including several months of elevated readings on core CPI inflation, evidence that the labor market has remained taut, a new surge in energy prices that raises the prospect of renewed pass-through effects to core inflation, and another blip in non-petroleum import price inflation.
These are certainly all good reasons for the two-year BEI rate to move higher on an ex-energy basis. But what is unusual about this episode is that this increase has not shown through to forward BEI rates beginning two years ahead.
... In contrast to the sharp run-up in the ex-energy measure of two-year BEI rate, the two-year three-year forward BEI rate is basically unchanged over this interval.
In fact, this measure is currently lingering around the lowest
level seen over the past several years. Thus, whatever the markets view as the source of inflationary pressure in the near term, they do not expect it to continue at longer horizons. That is, recent inflation developments have been seen as unfavorable, but transitory.