Mondial Chart of the Week: Inflation isn’t a problem…yet 📈

26 May 2020

Source: Bloomberg & Momentum Global Investment Management

What this chart shows

Breakeven rates indicate the market’s expectations for the average level of inflation over the specified time frame. It is derived from the difference between a normal and inflation-linked government bond of the same maturity. The chart shows current and historic #US breakeven rates over two, five, ten, and twenty-year horizons.

The #COVID-19 pandemic is a deflationary shock to the #global #economy as consumption in many areas has dried up, coupled with the second derivative impact from the collapse in the oil price (which has recovered although remains down nearly 50% year to date).

Markets took an increasingly negative view on (particularly near-term) inflation in the US. The two-year breakeven line shows that in March the market moved to anticipate deflation over the next two years, though it has moved to reverse some of this fall more recently. Clearly the pandemic is a short term shock to economies, unlike anything we have witnessed before. As markets look through the lockdowns and shorter-term disruptions, deflationary pressures lighten. This is reflected by the higher breakeven rates for longer time horizons.

Why this chart is relevant

#Inflation erodes capital over time. Any investor earning a nominal return less than the rate of inflation is ultimately losing money (in real terms). Whilst this is likely not going to be a problem over the short term with inflation very depressed, or even negative (of course deflation is hugely damaging too as consumers delay purchases given the expectation for lower future prices), there will come a time when it returns, as the chart implies over longer-term horizons.

One way this could come about is companies changing their attitude towards distant supply chains given the disruption caused by the global lockdowns. Moving towards localized supply chains for greater security would be inflationary.

Alternatively, and more obviously, the vast #monetary and #fiscal stimulus measures adopted by central banks and governments, not least in the US, will serve to bring money into the real economy and lift inflation.

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