Inflation-linked securities show deflation worries have abated.
The capital markets are ending the decade in decidedly new territory. There’s unprecedented liquidity underpinning the banking sector, official rates are still rock bottom, the major economies remain sluggish and the currency markets are under strain. All that makes interest-rate forecasting a challenge. But the markets themselves seem increasingly convinced that rates are headed up, to judge from recent behavior in the Treasury Inflation-Protected Securities Market.
The gap between yields on 10-year Treasuries and TIPS closed above 225 basis points on four days last week, the longest stretch since before the collapse of Lehman Brothers, according to Bloomberg.
That is already translating into benchmark rates inching up at the longer end of the curve, as the market switches from a focus on deflation to a more normal concern with inflation. In fact, on December 21, the two-ten stretch of the Treasury yield curve hit a historic high in steepness of 280 basis points, according to Reuters’ data.
Such a switch would in some ways make treasurers’ lives easier, since most financial modeling and rate forecasting, for the dollar, at least, is predicated on historical data that typically reflects the expectation of inflation, rather than deflation. The downside, of course, is a higher cost of funding, although this may continue to be offset somewhat by tightening spreads.