The bond market sees the rise in inflation subside, if not immediately

Nov. 11 (Reuters) – Bond markets expect spike in inflation highlighted by US retail price data on Wednesday to ease even as price pressures worsen very near term, although investor opinions are expected to waver amid divisions over how quickly the Federal Reserve will act to stifle price increases.

Data on Wednesday showed that the U.S. consumer price index rose more than expected in October as the cost of gasoline and food rose, resulting in the biggest annual gain since 1990, new signs that inflation could remain uncomfortably high until next year amid booming global supply. Chains.

Even as nerves grow in the face of accelerating short-term price pressures, longer-term measures show they are unlikely to last.

“The signals we are receiving from the market breakeven are that all is well, at least on longer term inflation trends,” said Subadra Rajappa, head of US rate strategy at Societe Generale in New York.

The Treasury break-even inflation curve, a measure of the level of inflation an investor could reach on a given yield on Treasury bills, shows that investors expect inflation to reach 4.80 % over the coming year, before falling to 3.65% in two years, 3.16%. in five years and 2.68% in 10 years.

The Fed’s preferred indicator, the five-year inflation rate, which measures where annual inflation is expected to be in five years, was the last at 2.30%. It is below the level of 2.41% reached on October 15, which was the highest since 2014.

“It hasn’t really gone over 2.50%, so for me that should reassure the Fed that the market is not integrating, or at least not expecting runaway inflation,” Rajappa said.

The Fed is targeting average annual inflation of 2% but said this would allow inflation to rise higher than usual to make up for the previous underperformance.

Fed officials, including President Jerome Powell, have maintained that the surge in inflation is “transient,” and Powell said last week he expects it to moderate next year. .

However, some investors are not so confident.

Two-year yields surged and the yield curve flattened as investors adjust to the prospect of tighter monetary policy, while federal funds futures show investors are ‘expect the US central bank to hike rates as early as July 2022.

“I think the most significant trend is the flattening of the curve, because the market is sort of assuming a more aggressive normalization path from the Fed,” said Ben Jeffery, interest rate strategist at BMO Capital Markets in New York.

Brian Reynolds, chief market strategist at Reynolds Strategy, said some difference in investor outlook can be explained by how they define “transient,” noting that some equity investors have interpreted the word to mean months, while fixed income investors see it as years. .

“There is a camp of equity investors who are convinced this is going to be permanent, and they seem to be playing in the interest rate space, forcing short-term rates to rise in anticipation of the Fed because of inflation, ”Reynolds said.

However, “this year, the fixed income market has always incorporated two years of rising inflation and then falling inflation thereafter. Over the past two months, they’ve built in a little more inflation over the next two years and a bigger inflation slowdown the following year, ”added Reynolds.

This means that the takeaway for now is that “the inflation debate has gotten a little more volatile,” Reynolds said.

TD Securities analysts, meanwhile, said this week that they expect inflation to “slow significantly” in 2022 as fiscal stimulus wears off and pressures on the economy wane. supply is easing, although price pressures could continue to increase in the very near term.

The bank expects annual CPI increases to fall to 2.1% by December 2022, and core CPI to fall to 2.3% during the same period. This compares to 6.2% and 4.6% last month.