Fidelity Macro Expert Puzzled With Fed's Extreme Actions: 'Inflation Will Presumably No Longer Be Clear, Present Danger'

Jurrien Timmer, the director of global macro in Fidelity's Global Asset Allocation Division, has raised questions on why the U.S. Federal Reserve is committing to an extreme policy when inflation will no longer pose danger.

What Happened: Timmer pointed out that the Treasury Inflation-Protected Security market and the Federal Reserve’s expected terminal rate were moving in the same direction until April but have been diverging ever since. 

“To me, this shows a relationship that has evolved from linear to non-linear,” he said.

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The current inflation spike is the most anomalous of the past 20 years, except for the financial crisis in 2008, which produced negative TIPS break-evens as a result of a liquidity squeeze, Timmer said.

Non-Linearity: TIPS is a bond indexed to an inflationary gauge to protect investors from a surge in inflation. A divergence in the TIPS rate and the estimated terminal rate indicates a divergence between the central bank’s actions and the potential path of inflation.

“If the TIPS signal is not a distortion caused by market structure or dysfunction, then what is it? My guess is that the TIPS market reflects the non-linearity (or cause-and-effect) of a Fed that is committed to bringing inflation back to its 2% target,” Timmer said in his tweet.

Mean Reversion: Market participants have already started factoring in a relatively less aggressive central bank later this week.

The SPDR S&P 500 ETF Trust (NYSE: SPY) closed 2.38% higher on Friday, while the Vanguard Total Bond Market Index Fund ETF (NASDAQ: BND) lost 0.2%.

Timmer believes that TIPS appears to be indicating a mean reversion in the inflation rate. 

“Perhaps we are at the start of a secular regime change for inflation, in which case the TIPS market is being too linear in its expectations for mean reversion," he said.  

"But if the Fed is going to get inflation back to target ... then the signal from the TIPS market looks to be one to believe. The question is how smooth the path to 2% will be."

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