In the wake of the Federal Reserve’s Open Market Committee (FOMC) meeting yesterday, I spent some time looking at the relationship between Quantitative Easing, inflation expectations, and risk assets.
A chart comparing 5y5y forward inflation TIPS breakeven & the S&P 500 (SPX) shows some interesting relationships. A correlation analysis suggest we may be in the midst of a deflationary slide analagous to that of 2010-11. Along with the correlation pattern, the divergence between 5y5y & SPX look a lot like 2010-11’s, when deflation took hold right after QE2, needing more flow (OT) to save the market:
If 5y5y can hold around 2.50%, then the Fed has successfully managed price levels (half of its dual mandate–employment being the other). If 5y5y continues sliding lower, then the $85B/month flow from open-ended QE3+4 will likely be increased. I’m not drawing any conclusions from this chart–just an interesting observation.