18 April 2021
Source: Bloomberg & Momentum Global Investment Management
What this chart shows The chart shows closely watched US inflation indicators over the past decade. To make things more confusing we have shown three different indicators: two show realised data, one (grey line) shows market expectations for future inflation. The two realised indicators gauge inflation based on a basket of goods. We won’t go into details here but the reason for the differences is ultimately what constitutes these baskets.
For example, US CPI includes food and energy prices which can be quite volatile because of commodity price fluctuations, whilst the core PCE measure excludes these. The US Federal Reserve focuses on core PCE when considering monetary policy changes and for this reason we have made this line bolder than the others. The 5y5y breakeven inflation (grey) line reflects inflation expectations for the period starting in 5 years’ time and lasting for 5 years. The latest CPI data release for March was the largest month-on-month increase since 2012.
Why this chart is relevant
Increasing inflation expectations had a significant impact on bonds over the first quarter with the 10-year US Treasury yield almost doubling. It is beyond dispute that realised inflation will rise in the coming months, not least due to year on year base effects, as well as the economic boom arriving at a time when there are certain supply shortages.
The Federal Reserve has continued its commitment to its ultra-loose policy, and preparedness to look through the spike in inflation ahead. Importantly, it has shifted its policy stance to focus on observables rather than estimates, as well as considering average inflation over time, and most members continue to expect interest rates to stay at current levels through 2023. However, as inflation expectations have increased, partly due to monetary stimulus and President Biden’s fiscal bills, market expectations for interest rate rises in the US have been brought forward.
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