Interesting Interest Rate Facts
Now that we're on the subject of interesting interest rate facts, I should point out that the bond market is now (at least seemingly) pricing in price deflation during the coming 5-year period. The yield for the 5-year regular U.S. government bond was 2.67% this monday. Yet the yield of the 5-year Treasury Inflation Protected Securitys (TIPS) was 3.74%. Meaning that unless the consumer price index fall by an average of more than 1% per year during the coming 5-year period, TIPS will provide better returns than regular bonds. While the current deflationary monetary trends make it basically certain that consumer price inflation will decelerate dramatically in the coming months from its current level of over 5%, consumer price deflation looks less likely. Of course if these deflationary monetary trends continued for a longer period, then consumer price deflation will inevitably follow. But given the determination of the Fed to use all available means to prevent deflation, it seems unlikely that monetary conditions will really be deflationary for sufficiently long time to achieve sustained consumer price deflation of more than 1% for the coming next 5 years.
As TIPS returns have consistently outperformed the return of regular government bonds for a long time, it seems that either bond traders are systematicaly underestimating future inflation and/or that the lower level of liquidity of TIPS relative to regular bonds are creating a liquidity premium for them.