Is the Bond Market Signaling a Change in Course for the Federal Reserve?

A recent run of weaker economic data, highlighted by the Citigroup Economic Surprise Index (CESI) plunging to -32 from 58 in mid-March has caught the attention of the US Treasury bond market. In the chart below, I plot the CESI against US 10 Year Treasuries. A falling CESI tends to be bullish for bonds.

Longer-term bonds are highly correlated with projections for federal funds in the future. Decomposing the 10 Year UST into its real and inflation components reveals an interesting insight. The recent drop in the implied break-even inflation rate is starting to pull on 2018 fed funds futures. At current levels, the implied fed funds rate at the end of 2018 is around 1.25%.