Inflation expectations have increased from around 1.40% in July to around 2% today. And as inflation expectations have increased, the expectation of a higher future fed funds rate has increased as well. The market was expecting a fed funds rate of just 60 bps in December 2018 back in July and hit a high of 1.72% on 12/16/16. However, inflation expectations seem to have found a new equilibrium around 2% since moving higher quickly immediately following the US presidential election. As inflation expectations have stalled out, the implied rate of fed funds has started to retreat. In just three weeks, over half a rate hike (if we assume a rate hike is 25 bps) has been removed from 2018 expectations as the implied fed funds rate has declined from 1.72% to 1.56%. If inflation expectations begin to retreat expect to see the implied fed funds rate to fall with it.
Article by Eric Bush, CFA – Gavekal Capital Blog
