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The Market – ‘Fed Rate’ Spread to ‘Inflation Rate’

February 20th, 2007

An article from Bloomberg titled “Bonds Lose `Masters of Universe’ as Volatility Falls” by Elizabeth Stanton, notes the following: “The annual inflation rate has averaged 2.8 percent since the start of 2000, down from 3 percent in the 1990s and 5.6 percent in the 1980s. Lower inflation has enabled the Fed to keep its benchmark overnight rate lower. It has averaged 3.24 percent this decade, compared with 5.12 percent in the 1990s and 9.86 percent in the 1980s.”  Using this data to do a very basic back of the envelope analysis, I derived the following:

Assuming this data is correct, one could interpret this data as suggesting the Fed is very concerned about any upside to inflation and thus has a very high ‘spread to inflation rate’ compared to historical averages.  Interestingly, the low spread average from 2000 to 2006 reflects the significant liquidity that has been pumped into the economy over that time period versus the prior two decades.  If anything, the current high spread may simply be an attempt to reduce the inflationary liquidity in the system.  With that said, comparing metrics for a point in time to that of historical averages can be tricky and misleading.

Entry Filed under: The Market