Inflation bets on the long bond

The liquidity premium theory of interest rates predicts that the Treasury yield curve steepens with inflation uncertainty as investors demand larger risk premiums to hold long-term bonds. By using the dispersion of inflation forecasts to measure this uncertainty, we find the opposite. Since the prices of long-term bonds move more with inflation than short-term ones, investors also disagree and speculate more about long-maturity payoffs with greater uncertainty. Shorting frictions, measured by using Treasury lending fees, then lead long maturities to become overpriced and the yield curve to flatten. We estimate this inflation-betting effect using time variation in inflation disagreement and Treasury supply.