Inflation in Check – Mission Accomplished
When I started trading, my understanding of market dynamics, particularly inflation, was fundamentally flawed. My sole frame of reference was school, where learning and applying lessons were typically solo endeavors. Even with team projects, the focus remained on individual opinions rather than collective insights.
The Individual vs. Collective Approach in Trading
That kind of mentality – I am the modern-day Jesus Christ, the new messiah with a perfect vision of where the markets are heading or, at the very least, a present-day Christopher Columbus, going boldly where nobody else has gone before is incorrect.
At the core of those natural tendencies is our conscious separation from others – my ideas, research, and discoveries are so special and unique that they are obviously correct. They are mine! What others thought about my ideas, research, or discoveries was of little interest to me because I had great belief in my abilities and very little belief in the skills of others.
Understanding Market Predictions Through Treasury Inflation-Protected Securities (TIPS)
However, life is not like I thought. While each human can be unique, a group of humans, even if not that talented individually, can achieve much better results in almost anything, especially market predictions.
I had to learn to respect the opinions of others, especially the opinions of other human beings who bet their own money. Yes, the future is unknowable, but market-derived predictions tend to consistently beat any individual Oracle.
Case Study: TIP maturing in October 2024
Consider two Treasury Inflation-Protected Securities (TIPS): one maturing in October 2024 and the other in April 2025. The insights derived from these securities are grounded in market data, representing collective opinions backed by real financial stakes rather than mere speculation. Data for these TIPS yields can be sourced from the Federal Reserve Economic Data (FRED) at FRED.
The TIP maturing in October 2024 offers a yield of 4.571%. To estimate the expected inflation for the upcoming three-month period, we need to analyze this yield in the context of current market rates.
Case Study: TIP maturing in April 2025
US bonds with 3-month maturities yield 5.327%, therefore, expected inflation = 5.327% – 4.571% = 0.756%. Market makers expect annual inflation to be 0.756% for the next three months before maturity.
That roughly translates into monthly inflation readings of less than 0.10%, on average, for each of the three months remaining until maturity – July, August, and September.
Unfortunately, the 9-month maturity bills are not on the run, meaning they are not that popular. They are still easy to find, just not as easy as the 3-month yields. At present, they are 5.05%. Therefore, the expected inflation for the 9-month future period is 5.05% – 4.147% = 0.903% annually.
Again, we can extrapolate that from July 2024 to March 2025, the average monthly inflation will not exceed 0.1% monthly, and the annualized inflation for the period will be lower than 1%.
The Role of Market Sentiment in Shaping Economic Predictions
The present seems to be an exciting time – former President Trump survived an assassination attempt, the sitting president, Joe Biden, dropped out of the race, and all kinds of rumors and theories abound about what Mr. Powell will or will not do.
Unfortunately, All those events are beyond the abilities of any human being to interpret correctly. They may even be beyond the skills of any group of people. However, the markets provide the best interpretation of those events.
And the TIPS markets are saying – “Mission Accomplished!” Inflation will be under control.