Market Extract: 10 Year Treasury Yields, CPI, and Historical Inflation

What’s going on in the market today, and how might your business, your portfolios, and your clients be impacted? The Market Extract aims to provide a condensed, clear, and highly relevant view, with insights from Advanced Asset Management Advisors’ investment committee to you. 

The stock market was mixed last week. The S&P 500 index gained 0.41%. Dow Industrials declined while the Nasdaq 100 and small caps gained. The most notable market change for the week is found in the 10 year Treasury yield, which dropped 10 basis points to 1.46% – the lowest level in three months and down 29 basis points from its March 31st high of 1.75%.

The 10 year Treasury yield change is most notable because the May economic report delivered a headline 4.93% increase in year-over-year CPI – the highest since September of 2008. Even though the Fed has accumulated massive Treasury bond holdings, the strength in the bond market indicates investors are comfortable with the Federal Reserve’s insistence that today’s inflation is transitory. However, history suggests it is too early to confirm that current inflation is truly transitory.

Some Good News for the Federal Reserve

The Fed has stated that they want 2% inflation over economic cycles. While they have not defined the length of the cycles they intend to look at, their plan is to accept higher inflation for “a while” to make up for periods of lower inflation. The good news is that soon it will not matter what the cycle definition is. Here’s why:

We know the Fed likes to use core personal consumption inflation as their measure. We tend to think that the CPI is representative of inflation experienced by the typical consumer – especially over long periods of time as the more volatile “non-core” food and energy prices tend to smooth out. So we looked at every trailing period for the CPI that ended in May.

The longest period dates back 73 years to 1948. The shortest is just a month ago. Every trailing period averaged over 2% annualized inflation, with the exception of those starting in September of 2005 through November of 2014 (the cumulative periods started between 6 and 15 years ago and are ending now). Looking back over these periods, cumulative inflation to date ranged from 1.6% to 1.99%. These are the only periods that do not meet the inflation goal of the Fed. If the CPI advances by 5.0% from its current level, all trailing periods will average over 2%. This could happen with 5.0% inflation over the next year, 10% over six months, or 2.5% annually over the next two years.

Pick any forecast period and it appears the Fed’s objective will soon be met. Guessing at the Fed’s definition of “the cycle” will then be irrelevant because every trailing cycle will exceed the objective.

Historical inflation numbers from periods starting between September 2005 and September 2014 through April 2021

The information and opinions in this report have been prepared by the investment staff of Advanced Asset Management Advisors (AAMA). This report is based upon information available to the public. The information herein is believed to be reliable and has been obtained from sources believed to be reliable, but AAMA makes no representation as to the accuracy or completeness of such information. Opinions, estimates and projections in this report constitute AAMA’s judgment and are subject to change without notice. This report is provided for informational purposes only. It is not to be construed as a recommendation to buy or sell or a solicitation of an offer to buy or sell any financial instruments or to participate in any particular trading strategy in any jurisdiction in which such an offer or solicitation would violate applicable laws or regulations.

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