WITH stockmarkets tumbling and the oil price below $30, some economists are once again worrying about global deflationary pressure. Low inflation can be toxic for economies when interest rates are also low (see a previous Explains). One warning light that is flashing red in America is market expectations of inflation, which have plummeted to lows not seen since the financial crisis. How are market inflation expectations measured, and why do they matter?

There are two popular measures of how much inflation markets expect. One is the difference between the return investors make on government bonds which are indexed to rise with inflation, and the return they make on bonds with no such protection. This gap—known as the treasury inflation protected securities (TIPS) spread—should rise and fall with investors’ reckoning of how much inflation is in the pipeline. Today, the five-year TIPS spread stands at around 1.1%—well below the Fed’s 2% inflation target. The second method relies on the market for interest-rate swaps. These are contracts where one party agrees to pay a fixed interest rate over a given period, in exchange for the other paying the inflation rate. An inflation forecast flows into the pricing of the fixed rate. Expected inflation calculated from “5 year, 5 year” swaps—which reflect the five-year period starting five years from now, in 2021—is today just 1.6%, suggesting the Fed might undershoot its target for as long as a decade. Worse, TIPS and swaps are tied to a measure of inflation—the consumer price index—which typically undershoots the index the Fed targets. That makes market signals even gloomier for the central bank.

Market expectations matter because they reflect the collective wisdom of thousands of investors, all of whom have real money at stake (and so have a strong incentive to bet wisely). In theory, market forecasts should reflect all public information—including all other forecasts in the public domain. Just as it is hard—some think impossible—for investors to reliably outperform the stockmarket, it should be tough to forecast inflation reliably better than the market does.

That should worry the Fed, whose central forecast is much more optimistic than the market’s; rate-setters expect inflation to return to its 2% target in 2018. But the Fed often points out that market measures of inflation expectations are not perfect. The prices of the bonds and swaps reflect the market’s central expectation, but will also vary with the risk on either side. For instance, if the risk of very high or very low inflation falls—ie, if inflation becomes more predictable—investors will accept lower returns on bonds that are not inflation-protected, even if their central forecast of inflation is unchanged. Investors may also charge a premium to hold swaps or inflation-protected bonds that are not frequently traded, because they are harder to offload. The “inflation risk premium” and “liquidity premium” can move around over time, obscuring movements in inflation expectations. Still, today it looks like markets really do expect lower inflation than the Fed. As well as disagreeing with the central bank’s inflation forecasts, the market now reckons interest rates will rise only once in 2016. In December, most rate-setters expected at least four rises.