“TIPS breakevens” are back above 2%, compliments of Mark Ungewitter (10/09/2012) Posted by John on September 10, 2012

TIPS breakevens” are back above 2% compliments of Mark Ungewitter (10/09/2012

Want to understand the stock market?  In recent years, inflation-protected bonds (i.e. TIPS) have provided an important clue.  With Ben Bernanke first suggesting and now articulating an inflation target of 2%, TIPS breakeven spreads, which measure the bond market’s best guess of future CPI, have been a reasonable guide to monetary policy.  When breakevens have dipped below 1.5%, the probability of quantitative easing has increased, helping equities to rally.  When breakevens have exceeded 2%, equities have topped out, as the prospect for QE goes off the table.  See char above.

With this relationship in mind, we now face a very interesting situation.  The market is expecting a new round of QE while breakevens are beginning to exceed 2%.  So, how will this play at the upcoming FOMC meeting?  The Fed is likely to disappoint the market unless it develops a new rationale for QE based more on full employment than price stability.  While such a departure was hinted at Jackson Hole, Bernanke is unlikely to pull the trigger just seven week’s before a national election.  Or will he?  This could be one for the history books… and Bernanke knows it.