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The Economics of Second Liens   Bernanke: A Wise Man at the Fed
Jan 16 2008 4:30PM EST

Inflation Expectations: Coming Down

Back at the beginning of the year, I recommended putting in a non-competitive bid for 10-year TIPS at the January auction on January 10. Now that's happened, I can link to the results: my hypothetical bid would have picked up a 10-year inflation-indexed bond for 99.72 cents on the dollar, to yield 1.655% over inflation. The 10-year bond presently yields 3.708%, which means that the market is pegging inflation over the next 10 years at 2.05%, slightly higher than the Fed's comfort zone, but less than the 2.4% well below the 4.1% at which the CPI rose in 2007.

Interestingly, inflation expectations seem to have come down in the past six months. On July 12, the 10-year TIPS auction came with a real yield of 2.749%, while 10-year bonds were yielding 5.12% - for an inflation expectation of 2.37% over ten years. Since then, a panicked Fed has slashed interest rates and clearly signalled that it's going to cut further - but the market is now less worried about long-term inflation than it was. Weird, no?

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