Inflation and forecasts of GDP

Yield on TIPS, Treasury Inflation Protected Securities, weekly, January 1st 2003 to July 27th, 2012

I’ve written previously about the inflationary pressures that are entering the system but curiously the yield on Treasury Inflation Protected Securities or TIPS went negative two days ago. What’s it all mean? Well, TIPS return to investors a real, not nominal, amount. This amount changes as inflation changes, thus the attraction to investors who are compensated for making long term investments. However if present trends continue we’re not going to see inflation but deflation. An important point to keep in mind but this is anecdotal, and there is little academic evidence to support this (personal) view: current yields on TIPS have strong predictive power of future GDP. In other words, TIPS are saying US economic growth will remain weak for years to come. However mitigating this view is the fact that the fixed income markets are still be heavily manipulated by the government, in the guise of Quantitative Easing and Operation Twist. Strange times to be sure.

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