The Federal Reserve may start raising interest rates next year for the first time in nearly a decade, but the focus at the moment is on deflation risk, or so it seems by way of the market’s softer inflation forecast via a closely followed yield spread in Treasuries. The implied outlook for inflation slumped to a three-year low of 1.82% on Nov. 26, based on the difference for the nominal 10-year yield less its inflation-indexed counterpart. This market-based estimate is down sharply from the recent peak of 2.29% as of this past July 30. It’s unclear how much of the market’s focus on deflation risk is tied to worries about the macro outlook in Europe and Asia vs. the US. This much is clear: if Mr. Market continues to lower his inflation estimate, it’s going to be tougher to argue that the US economy is immune to the macro troubles that are bubbling elsewhere in the world.
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