Early Inflation Warning Signs for Investors

September 14, 2012 ( – Inflation has remained steady in the U.S. and most developed countries in the aftermath of the economic crisis.

By Corie Russell | September 14, 2012
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With the exception of Japan, deflation has failed to take hold despite low levels of economic activity and high unemployment rates. But two risks some type of shock or monetary policy mistake have the potential to incite significant and sustained increases in inflation.

According to J.P. Morgan Asset Management, there are eight early warning signs to monitor in order to detect increasing imbalances that could ultimately lead to upward pressure on prices. These indicators range from surveys that track inflation expectations and labor market dynamics, to indexes that track and capture global trends in available resources.

“I wouldn’t think about each of these indicators in isolation,” Michael Hood, strategist at J.P. Morgan Asset Management, told PLANSPONSOR. He emphasized that there is little cause for concern at this point unless several of these warning signs are triggered simultaneously.

Hood said he does not see an inflation problem on the horizon, but that warning signs from J.P. Morgan’s report, “Managing Inflation: Its drivers and eight early warning signs,” can help investors prepare. Here are a few to watch for:

The 5y5y Forward Inflation Breakeven  

The Federal Reserve watches the 5y5y forward “breakeven” rate as a gauge of medium-term expectations. The breakeven is the difference between the nominal U.S. Treasury rate and the yield on Treasury Inflation-Protected Securities (TIPS).

Since 2000, the breakeven rate has averaged 2.7%, somewhat higher than the 2% inflation target. The current 5y5y forward breakeven is roughly 2.4%, below its medium-term average. A sustained move significantly above 2.7% (3% or higher) would signal a possible deanchoring of inflation expectations in the market, with a rise beyond 3.3% putting this indicator in “red” territory, the report said.