Markets Trust Fed on Inflation

Following up on posts and comments (Brad DeLong) about the credibility of the Federal Reserve when it comes to controlling inflation, I pick the following from my office desk, dated Sept 1. As the bondmarkets - the nominal and the real-yield bonds - show; the Fed is expected to neutralize most of the inflationary impulse from swings in the labor-market:

The strong market impact the non-farm payroll figures have had historically is summarized in the following table. The market moves on the day the figure have been released, expressed as yield change, is tabulated together with the released figure, and the expectations for it according to Bloomberg's economist survey. Over the last 12 months, 10 year nominal yields have tended to increase about 0.13 percentage points (13 bps) for every unexpected extra hundreds of thousands of people on the payrolls, 10 year inflation-linked real-yield treasury bonds, TIPS, have tended to increase 10 bps, and their implied expectations of future inflation, the break-even spread, has tended to increase only as little as about 3 basis points.

As evident from these figures, the market trusts the Federal Reserve to, at least in the long run, counteract most inflationary impact from changes in payrolls. The final bond-market impact of the economy's performance could hence be viewed as channeled mostly through real-yields.

Non-Farm Payrolls - Change in thousands and yield moves in bps on announcement days:

Date..............Figure...Expect..Surprise..10y Treas..TIPS..B/E

2003-08-01...........-44.......10.......-54......-2.2...2.2..-4.4

2003-09-05...........-93.......20.......-113....-15.6...-15.9..0.3

2003-10-03............57.......-25.......82......20.6....13.2..7.4

2003-11-07...........126.......65.......61........3.0....0.1...2.9

2003-12-05............57.......150......-93.....-13.5...-12.0..-1.5

2004-01-09.............1.......150......-149.....-17.5...-10.5..-7.0

2004-02-06...........112.......175......-63......-9.0....-7.2..-1.8

2004-03-05............21......130......-109.....-16.6...-12.1..-4.5

2004-04-02..........308.......120.......188......26.5....22.2...4.3

2004-05-07..........288.......170.......118......17.3....13.5...3.8

2004-06-04..........248.......225.......23........6.2.....5.3...0.9

2004-07-02..........112.......250.......-138.....-10.4...-9.0..-1.4

2004-08-06..........32.......240.......-208......-18.0...-15.9 -2.1

2004-09-03...................150