Deflation is new fear on Wall Street

For all the concern about inflation among pundits and the press, markets increasingly believe deflation has become the economy’s biggest problem

The 2-year U.S. breakeven inflation rate — the difference between the 2-year Treasury yield and the 2-year Treasury Inflation-Protected Security (TIPS) yield — has fallen from around 2.55% to 2.47%.

That decline means investors now expect inflation to average roughly 2.47% per year over the next two years.

Unlike survey-based forecasts, the breakeven rate reflects real-time pricing in the bond market, making it a direct gauge of investor expectations.

When the breakeven rate collapses, it signals that investors believe monetary policy is too tight, requiring the Fed to cut rates more aggressively.

If policymakers fail to respond, the risk is that they’ll miss the deflation turn.

“Deflation is the problem,” wrote macro analyst and Forward Guidance co-host Tyler Neville. “The Fed is way behind on easing.”

“The Fed will need to ease even faster than current expectations to combat the tightening credit cycle,” Neville added in a separate post.

These market signals stand in contrast to headline economic data.

The Consumer Price Index (CPI) and core Personal Consumption Expenditures (PCE) index have both reaccelerated toward 3%, remaining well above the Fed’s 2% target.

However, bond markets suggest investors view those figures as temporary distortions.

Are deflation fears gaining ground?

If the deflation camp is correct, the U.S. economy may be rapidly losing momentum, setting the stage for slower growth and even the risk of recession.

While official GDP figures and real-time trackers show little evidence of an immediate downturn, cracks in the expansion are beginning to appear.

Rising unemployment and a drop in job openings have become central concerns for policymakers, especially after downward revisions to 2024–2025 employment growth data.

The labor market, once a pillar of post-pandemic strength, now appears to be slowing.

Earlier this year, economist David Rosenberg of Rosenberg Research warned that the U.S. economy could be heading toward a “deflationary shock,” driven by the combined effects of new tariffs, slowing immigration, and the long-term drag of an aging population.

His analysis underscored how quickly the policy focus can shift from fighting inflation to trying to stave off deflation.

“[I]t amazes me how all the bond bears, inflation-phones, and Fed policy hawks are missing this secular shift as they continue to play by the old rules,” Rosenberg wrote in August.