Inflation expectations take a dive

Two closely watched measure of inflation expectations have fallen significantly in 2014. This is the current main worry for the Fed. The 5-year break-even has declined by approximately 40% from a 2% level to now 1.2%. The longer term break-even inflation rates, 5-year , 5-year forward rate has also fallen but it is still slightly above 2%. The worry for both these trends is that even with inflation falling from the oil price decline shock, nominal interest rates have also declined. Fixed income markets have been moving in lock-step with the inflation declines.

While many have talked about the steady policy behavior of the Fed over the last year, it seems that the Fed has switched from concern about unemployment to now inflationary expectations as the key driver for policy. With break-evens closer to 1% than the 2% target, it is hard to see the Fed speeding up any policy decisions.