Treasury yields continue to fall, making mincemeat of the idea that the Federal Reserve will continue to raise interest rates this year. Everything could change, of course, if the incoming economic data turns out to be stronger than expected. The main event for this week: January payrolls, starting with today’s preliminary estimate for the private sector via ADP’s data, followed by Friday’s official numbers from the US Labor Department. Meanwhile, Mr. Market has been slashing rates across the Treasury curve in the wake of revived worries about economic growth.

The 2-year yield—considered the most sensitive for rate expectations—has fallen sharply this year, decreasing to a three-month low of 0.75% yesterday (Feb. 2), based on daily data from Treasury.gov. The benchmark 10-year yield’s tumble is even more dramatic, sliding to 1.87%–the lowest level since last April.

There’s a bit of good news in that the market’s five-year inflation expectations remain relatively stable, albeit at subdued levels vs. recent history. Future inflation implied by the yield spread for the nominal 5-year yield less its inflation-indexed counterpart is currently 1.14% as of Feb 2. That’s a middling rate in the context of the last several months, but for the moment it’s encouraging to see that it’s not collapsing. The 10-year inflation forecast, however, looks weaker in context with its recent range and so there’s still plenty of uncertainty about what happens next.

Note that the US stock market (S&P 500) and the implied 10-year inflation rate are again moving in lockstep, and for all the wrong reasons. The recent slide in equities has been accompanied by a drop in inflation expectations. The return of a tight correlation here is a sign that the crowd’s becoming increasingly anxious about disinflation/deflation risk. That’s a worrisome development, particularly if it continues and the outlook for inflation trends lower. Accordingly, this is a clue that the Fed should refocus efforts on raising expected inflation.

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