This chart brings a smile to Ben Bernanke’s face, note’s BTIG’s Mike O’Rourke:
We like to look at the spread between the 10 year Treasury and the 10 year TIP (Chart1) as a measure of inflation expectations. Since its August low of 151 basis points, the spread has widened to 217 basis points. The peak range for the spread earlier in the year was in the 240-246 basis point level. Those levels were on the low end of the pre-crisis range during 2004-2007. In essence, as the economy rebounded in Q4 2009 and Q1 2010, inflation expectations had almost returned to some level of normalcy. The double-dip and deflation fears of the summer pushed expectations down to that 151 basis point level in August. In an environment where deflation is a notable fear, such a contraction is a concern even though that level is significantly higher than the 0% reached during the height of deflation fears in Q4 2008. The reason the Fed is likely happy with the progress their jawboning has made is the fact that inflation expectations have been picking up as represented by the spread widening. The reason is not because 10 year yields are rising, but because TIPS yields went negative. Therefore, in the first half of the year when the spread was at these levels, the 10 year yield was up closer to 4% as opposed to the 2.55% of the current environment. Not only have they brought inflation expectations back into the equation, but they managed to keep long yields down simultaneously. Keeping those long term yields down is the stated intention of QE.