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Inflation, the Fed and the FIG

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ECRI’s Lakshman Achuthan joined CNBC to discuss ECRI’s U.S. Future Inflation Gauge, the inflation outlook, the Fed and the bond market.

Both the Fed and the bond market have been way behind the curve in anticipating the inflation cycle downturn, and the plunge in the market’s inflation expectations tells you that’s the key reason yields have plummeted.

ECRI’s U.S. Future Inflation Gauge, or FIG, was far more prescient. It leads inflation cycle turning points – and in fact, also leads inflation expectations.

Because the FIG turned down in early 2018, it was clear to us by last summer that a fresh inflation cycle downturn was at hand.

Certainly, that inflation cycle downturn wasn’t obvious to the Fed, which hiked in September and December.

And the bond market was also caught flat-footed, with market inflation expectations – the spread between 10-year treasury yields and 10-year TIPS yields – remaining high through late fall. These exaggerated inflation expectations made bond market “royalty” pound the table about a bond bear market, pushing treasury yields near 3¼% last fall.

The subsequent plunge in treasury yields, culminating in the Powell pivot in January – as well as the last six weeks’ freefall – was driven largely by plummeting inflation expectations.

That downturn was clearly anticipated by ECRI’s FIG, which has stayed in a cyclical downturn for 15 months, dropping as of this morning to its lowest reading in over three years.

The bottom line is that the U.S. inflation cycle – a concept that most economists, including those at the Fed, don’t seem to understand – will stay in a downturn.

It’s really this lack of understanding of the inflation cycle that was behind the Fed’s abrupt about-face early this year.

Yet, ECRI clients were alerted to these developments in summer 2018, and were on the right side of this drop in rates.

Indeed, on the heels of the December 2018 rate hike, Achuthan said on CNBC’s Closing Bell, “We have our inflation cycle downturn call. The Fed is going to get there whether they like it or not. They are going to become more dovish.”

The rest is now history.  

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