5% Chance Of Sustained Deflation--SF Fed

You would not know it by listening to Zimbabwe Ben and company, but the chance of sustained deflation in the US is extremely low according to research from the San Francisco Fed.

The full article is available here

The bottom line from the Fed's own research:

The recent economic slowdown has raised concerns about the possibility of sustained deflation in the years ahead. However, a refined model of inflation-indexed and non-indexed Treasury bond yields, which captures accurately the possible inflation outcomes perceived by bond investors, suggests that the probability of sustained deflation is just 5.3%. The model accounts accurately for the behavior of inflation-protected Treasury bond yields during the financial crisis and could prove reliable in evaluating deflation risk.

Click chart for larger image.



 
 
 
 
 
 
 
 
 
 
 
 
 
 
What this research indicates is that the only people even mentioning deflation are unconnected academics (most of whom said housing was not in a bubble). The market sees no such outcome. The only time when the market saw the possibility of prolonged deflation was after Lehman's collapse when the entire financial system was almost destroyed. You can see from the chart below what the market thinks of inflation (blue line--5 year break even rate). One thing to keep in mind about this chart is that it only goes to Aug 13. 2010. The 5-year break-even rate has rebounded during the interim to 1.55%. So far, the bond market is predicting low inflation, at least for the time, but the risk is to the upside not downside. 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
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