Quantitative easing: Possible outcomes

Ever since the Aug 10th FOMC statement—in which the Fed announced it would be buying longer-term Treasury securities with the proceeds of its maturing or prepaid Agency and MBS holdings—there has been a very interesting and tight correlation between the slope of the Treasury yield curve from 10 to 30 years and the market’s own inflation expectations. This is shown in the above chart, with the red line representing the 5-year, 5-year forward inflation expectations embedded in TIPS securities, and the blue line representing the slope of the Treasury yield curve from 10 to 30 years. What stands out is that the slope of the longer end of the yield curve is now a good proxy for the market’s inflation expectations. That is at it should be, of course, since the higher inflation expectations, the greater the premium that investors should demand to own 30-year bonds instead of 10-year bonds….

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