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A Possible Future Inflation Bubble

shutterstock_193136405We may be heading toward an inflation bubble, Bloomberg reports. Nominal yields on five-year Treasuries are negative when adjusted for the price outlook, and on the Federal Reserve’s gauge to measure long term inflation expectations, the rate projected for 2022 is falling.

Although real interest rates are often parallel to real gross domestic product, Deutsche Bank AG reports that real rates are two percentage points below what’s implied by the momentum of the U.S. economy. "We see real rates as extremely misvalued if not in a bubble," Deutsche Bank analysts, led by Chief Global Strategist Binky Chadha, wrote in a note on Friday.

Deutsche Bank further states that the tightening labor market will fuel inflation in the coming months when adjusting for the impact of the dollar, and less slack in the jobs market will boost the efficiency of U.S. economic output.

However, Deutsche Bank’s view appears to be an outlier. Steve Feiss, an interest-rate strategist at Government Perspectives LLC says rates “are far from a bubble”, or are overly distorted through monetary policy.

"The Fed wants to nudge real rates higher, and as commodity base effects dissipate, we could see that," said Naufal Sanaullah, a trader and founder of the website MacroBeat. "But I think Trump will want to utilize low real yields as a way to stem dollar-appreciation pressure."

Analysts had previously predicted an increase in public deficit and corporate spending this year, though instead we’ve faced low real yields. Federal Reserve Chair Janet Yellen had stated at a press conference following the rate increase that policy rates will stay anchored by historical standards. In addition, the neutral rate is expected to “rise somewhat over time” as some effects of the crisis where off.

With the negative outlook, Goldman Sachs Group Inc. and Bank of America are advising clients to shun longer-dated obligations.

About Author: Seth Welborn

Seth Welborn is a contributing writer for DS News. He is a Harding University graduate with a degree in English and a minor in writing, and has studied abroad in Athens, Greece. An East Texas native, he also works part-time as a photographer.
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