March 17, 2008

Holding the real rate constant, the changing futures rate reflects the market’s changing inflation expectations. Thus, the rising yields may very well be signaling an increase in the U.S. inflation rate. On the other hand, given the inflation rate, the changing T-bill yields reflect the market’s expectation about the economy’s real interest rate. This interpretation points to an acceleration in the real economy beginning during the third quarter and extending well into 2009. The market’s interest rate expectations suggest three possibilities: Faster growth, higher inflation or both during the latter part of the year. So which one is it?

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