Inflation hurts for many reasons, but one of the most important is that it usually means higher interest rates. Yet in the past year, while inflation has jumped 7 percentage points, the Fed’s short-term interest-rate target has gone up just 1.5 points and the 10-year Treasury note yield just 1.9 points.
The gap reflects a belief by investors that in a few years, inflation will relatively painlessly slide back to around 2%, the Federal Reserve’s target, allowing rates to return to the ultralow levels that prevailed before the Covid-19 pandemic. What if instead inflation remains stubborn and rates have to rise a lot more? That would spell trouble for an economy where asset values, private and public debt have risen on the assumption that rates will remain historically low.