Bond Traders Bet on Recession-Level Inflation Plunge Next Year

(Bloomberg) — If the bond market is correct, US inflation is about to plummet at the pace that it did during the 2008-2009 global financial crisis.

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The gap between yields on one-year Treasury Inflation-Protected Securities and similar-dated nominal government notes stands at 2.18%, reflecting market expectations for the average inflation rate over the coming year. That would require price gains to slow by more than 5 percentage points, a pace seen in only three instances in the past six decades.

Each of those occasions occurred during or just after a recession, underscoring expectations for a US downturn after the Federal Reserve’s steepest policy tightening in a generation. Ten-year Treasury yields are lagging two-year rates by the most since the early 1980s, with the inversion — often seen as a harbinger of economic pain — hitting a new extreme of 85 basis points last week.

“Headline inflation is peaking and market participants appear keen to look forward, and remain on the lookout for signs that monthly inflation momentum has peaked,” said Andrew Ticehurst, a rates strategist at Nomura Holdings Inc. in Sydney. “Lower breakeven rates could also be signaling increasing concern regarding the possibility of recession.”

Read: What to Expect in the Last CPI Report of 2022 and the Year Ahead

The headline inflation rate tumbled by 5 percentage points or more in a 12-month span on only one occasion since TIPS were first sold in 1997 when it dropped as much as 7.9 percentage points in the wake of the collapse of Lehman Brothers Inc. in 2008. Price pressures fell at a similar pace in 1981-82, after Volcker-era rate hikes set off a recession, and in 1975-6 in the face of a sharp economic downturn.