The Federal Reserve Board published research examining how changes in expected inflation transmit to firm-level corporate credit spreads and equity returns. Using inflation swap prices, the paper finds that the sensitivity of risky asset prices to inflation expectations is time-varying and depends on how investors interpret inflation news relative to real economic growth. In periods of “good inflation,” when inflation news is perceived as more positively correlated with real growth, increases in expected inflation substantially compress corporate credit spreads and lift equity valuations. In “bad inflation” periods, these effects weaken and can reverse. The authors present an equilibrium asset pricing model in which a time-varying inflation-growth relationship and persistent macroeconomic expectations generate these dynamics.
Federal Reserve Board 2025-01-31
Federal Reserve Board publishes study on how good versus bad inflation regimes shift credit spreads and equity returns
The Federal Reserve Board released research on how expected inflation changes affect corporate credit spreads and equity returns, using inflation swap prices. The study shows asset price sensitivity to inflation expectations varies over time, influenced by investor perceptions of inflation relative to economic growth. In "good inflation" periods, expected inflation compresses credit spreads and boosts equity valuations, while in "bad inflation" periods, these effects may weaken or reverse.