The yield on 10-year Treasury bonds had been slowly rising by roughly 9 basis points per month since last summer as the prospects for a vaccine and the economy improved.
But since the end of January, there has been a jump of 50 basis points, with 10-year yields twice breaching 1.5% and then 1.6% in the first week of March.
This has set off a flurry of commentary about the Federal Reserve having to reverse course and respond to higher expectations for inflation. Yes, inflation expectations are higher than a month ago. But in our estimation, that has to do with an improving growth outlook and is not a material risk to the economy linked to inflation.
First, inflation expectations dropped between February and August last year during the first six months of the pandemic, and have yet to fully crawl back to what would be reasonable levels of inflation.
A year ago—at the end of February and before the economic shutdown—the Aruoba Term Structure of Inflation Expectations model reported by the Philadelphia Fed estimated that inflation would be 2.07% in 12 months and rise to 2.24% in 10 years. We can assume those are normal levels in an economy operating at full employment.
Fast forward to the end of January—before the jump in bond yields—and the ATSIX model estimated that inflation would be 2.01% in 12 months and rise to 2.16% in 10 years. At the end of February, the ATSIX model estimated that inflation would be 2.09% in 12 months and rising to 2.19% in 10 years.
The upshot is that there’s not much difference between last year and this year, or last month and this month.
If anything, the anticipated increase in inflation expectations in 12 months is in line with our forecasts for an increase in demand (and a spurt in consumer spending) as vaccines allow for the further reopening of the economy and as disrupted supply chains work to get back to speed to meet that demand.
For more information on how the coronavirus pandemic is affecting midsize businesses, please visit the RSM Coronavirus Resource Center.