Forecasting Inflation: What Affects TIPS?

This column was originally published on RealMoney on Feb. 12, 2008 at 11:48 a.m. EDT. It's being republished as a bonus for TheStreet.com readers. For more information about subscribing to RealMoney, please click here.

Man does not live by bread alone, which considering what the price of wheat has been doing (cash spring wheat at Duluth is up 236% from a year ago), is no doubt a good thing. And given the propensity of government statisticians to exclude food and energy prices from various inflation measures, I guess we all can ignore higher grocery bills in the months to come.

Russian civilians trapped in Leningrad during the horrific World War II siege resorted to making ersatz bread from materials such as sawdust. I look forward to The Core Inflation Cookbook, by Ben Bernanke as told to Rachael Ray.

Treasury Inflation-Protected Securities (TIPS) are based not on any bogus core inflation measures, but rather on the All-Urban Consumer Price Index, not seasonally adjusted (CPI-U). Both food and energy are included, as are difficult-to-understand measures, such as owners' equivalent rent and hedonically adjusted prices for various consumer goods.

TIPS' Forecasting Record

As I discussed in September 2007, TIPS are anything but a pure measure of inflation expectations. The yields on conventional Treasury notes have been forced unnaturally low by the flight-to-quality trade. Even so, the 10-year breakeven rate of inflation of 2.32% seems wildly disconnected from reality. ...