By Dhaval Joshi, Chief Strategist at BCA Research
Arguably the most significant financial asset-class in the world is the inflation protected bond market. The inflation protected bond market sets the most fundamental price in economics and finance: the long-term real interest rate. By comparing the long-term real interest rate with the long-term nominal interest rate, we can also derive long-term inflation expectations. Yet the most significant financial asset-class is also the most insignificant. Compared to the behemoths that are the $50 trillion US stock market and the $25 trillion of US treasury debt, the $1.5 trillion US treasury inflation protected securities (TIPS) market is minuscule. Some economies do not even have inflation protected bond markets.
Unfortunately, the relative paucity of the inflation protected bond market (as well as associated markets such as inflation swaps) creates a problem. Namely, the activity of short-term hedgers distorts the inflation expectations that these inflation markets present to us. Right now, these distortions are masking worrying uptrends in inflation expectations in both the US and euro area.
