Photo: Reuters/Joshua Roberts
US Treasury Secretary Janet Yellen has voiced support for the Biden administration's call for a global minimum tax rate. Photo: Reuters / Joshua Roberts

Outgoing Fed Chair Janet Yellen warned yesterday that there is “some hint” that inflation expectations have been drifting lower, warning that “it can be quite dangerous to allow inflation to drift down and not to achieve over time a central bank’s inflation target.”

In fact, there’s a strong and measurable trend in inflation expectations, as gauged by the so-called breakeven rate in the Treasury market (the inflation rate at which investors in ordinary Treasuries and inflation-indexed Treasuries would obtain the same total return).

The breakeven inflation rate typically tracks the broad commodity index SPGSCI (including oil). The regression graph of 10-year breakeven inflation vs. commodity prices, though, shows a distinct downward trend in the residual line.

10-yr breakeven vs SPGSCI
Source: Bloomberg

When a linear trend variable is added to the equation, breakeven inflation follows the combination of commodity prices and a declining trend very closely (83% fit).

10-yr vs SPGSCI and linear variables
Source: Bloomberg

Asia Unhedged has discussed several reasons for lower inflation than the Fed expects: the growth of e-commerce at the expense of traditional retailing, global productivity growth that suppresses import prices for manufactured goods, an aging and more cautious workforce willing to trade pay gains for job security, among others. The much-vaunted Phillips Curve (higher inflation as a consequence of lower unemployment) hasn’t shown itself lately. So Yellen’s dovishness has a reasonable grounding in fact.