“Also I don’t think these 5-year TIPS can have negative real yields. I think they are now CPI+1.78% or so. So their real yield will be 1.78% (pre tax).”
METARs, several of you simply don’t have the data on TIPS or understand how inflation expectations work.
The Fed bases its inflation expectations on the bond market. Note that the 10-year nominal TIPS yield was negative between January 2020 and May 2022. Since inflation was running between 1.5% and 2% during that time, the real yield of the TIPS, like the Treasury, was under 1%.
The 5-Year, 5-Year Forward Inflation Expectation Rate is the difference between the 5 year Treasury and the 5 year TIPS. It is currently 2.18%. An investor who believes that inflation will exceed this over the next 5 years should buy TIPS, not Treasuries.
The Fed didn’t say that they estimate the forward inflation rate will be higher. They said that they want their tightening policies to bring real inflation down to that level. They predicted a fed funds rate of perhaps up to 4.5% might be needed to do that but there is high uncertainty since they are flying by the seat of their pants and readjusting as new data comes out. They want PCE inflation to be around 2% for several months to be sure it won’t pop back up as it did in the 1970s.
Wendy