When Will the Fed Stop Raising Rates? The Number to Watch.

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Interest rates are rising—slamming the stock market—as the Federal Reserve tries to tamp down inflation not seen in generations. Watching the market’s expectations for how fast prices will rise is one way to get a sense of when the pressure from the central bank might abate.

The current rate of Inflation of above 8% is way too high. The good news for investors is that inflation expectations aren’t anywhere near that level.

If they were, the Fed would have a much tougher job getting the pace of price increases back to its target of 2%. Rates would have to rise much higher to slow the economy enough to keep companies from raising prices and workers from demanding higher pay to make up for that.

A good way to track inflation expectations is to look at the difference in yields between regular Treasury bonds and Treasury inflation-protected securities, or TIPS.

Treasury bonds are easy to understand. They pay interest twice a year and give investors back the face value at maturity. TIPS’ face value increases at the rate of inflation, and the interest paid is based on the adjusted face-value amount, so investors don’t lose any purchasing power because of inflation.

Currently, the 10-year TIPS are yielding only about 0.2%. The 10-year regular Treasury bonds yield about 3.1%. TIPS’ face value would therefore have to be lifted by 2.9% for the inflation-adjusted Treasury debt to offer the same total return as regular 10-year notes.

That difference in the yield is the current inflation expectation over a 10-year horizon.

Investors should watch that number to see if that expectations are getting out of control. If they are, then the Fed will be raising rates higher and faster. If they move toward 2%, then there will be far less pressure on the Fed to raise interest rates, and the central bank is likely to take a less aggressive stance.

Investors can also make sure that there aren’t big differences between short-term and long-term inflation rates. The 5-year expected inflation rate is about 3.2%, a little higher than the 10-year break-even inflation rate. That makes some sense because inflation rates are expected to come down from today’s high levels over time.

Both the 5- and 10-year expectations are down from recent peaks. That is one small sign that Fed policy is working.

Investors can find the data free via the Federal Reserve Bank of St. Louis and its Federal Reserve Economic Data, or FRED, website. It publishes both the 5-year and 10-year expectations without making investors do any math.

Fed rate increases, and the prospect for more, have led to some wild trading in the stock market lately. The

S&P 500
and

Dow Jones Industrial Average
finished up 3% and 2.8% on Wednesday, but closed down 3.6% and 3.1%, respectively, on Thursday.

Write to Al Root at [email protected]