Low Inflation Likely to Persist, Says Wilmington Trust

Terry Flanagan

While bond yields have moved lower during 2014, trading in the 2.0%–2.5% range on the 10-year U.S. Treasury, yield levels will move higher over the next seven years, yet will be kept in check by benign inflation expectations, according to Tony Roth, chief investment officer at Wilmington Trust.

Roth predicts that inflation will average 1.9% across the seven-year horizon, with higher rates toward the end of the period.

Evidence for persistent low inflation, despite the likelihood of the Federal Reserve pushing interest rates higher, is provided in the form of a yield curve for U.S. Treasuries which shows a flattening at the longer end.

“Right now we’re seeing that the futures curve is much tighter towards the long end of the horizon than the short end,” Roth said during a conference call.

Nominal yields for 10-year government bonds were 2.33% as of Sept. 30, 2014, and were projected to peak at 3.58% by the end of 2012. Six-month yields, which were 0.08% as of Sept. 30, 2014, were projected to peak at 2.15% by the end of 2021.

Wilmington Trust anticipates real returns to be from near-zero to negative based on certain assumptions for growth, inflation and monetary policy decisions. However, an unlikely occurrence such as deflation would call for an adjustment.

“Because we expect inflation to stay very low, we expect to see that continue to be the case. So as short-term rates are pushed higher, we expect to see a bit of a decoupling between actual rates and futures on the short end, while we expect to see a flattening at the long end of the curve,” Roth said. “We think that provides further confirmation that the bond market is telling us that inflation is really going to stay low for a considerable period of time.”

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