A market-based measure of future inflation expectations is back near the top of its 10-year range, posing potential challenges to price gains and causing potential disruptions in financial markets.
5-Year, 5-Year Forward Inflation Expectation Rate
The 5-year, 5-year forward inflation expectation rate is a significant indicator of average inflation expectations for the five-year period starting in 2028 and ending in 2033. Currently, this rate is hovering around 2.5%, which is considered high compared to levels observed since 2013. Policymakers are particularly interested in this gauge as it provides insight into longer-term trends without being influenced by short-term developments.
Concerning Trends
What is more alarming than the almost 2.5% level itself is the fact that the 5-year, 5-year forward breakevens, also known as the 5y5y rate, have been gradually increasing by about 20 basis points since mid-July. This upward movement is significant because it has occurred in the absence of any major news or events. Will Compernolle, a macro strategist at FHN Financial in New York, describes this as a “huge inflection point,” highlighting the unexpected rise in future expectations.
These findings suggest that there may be potential risks to price gains and financial markets as inflation expectations continue to rise.
Concerns about Inflation Upside Risks
The recent change in the 5y5y forward rate has raised concerns about potential upside risks to inflation. Despite extensive research, no clear cause for the 20-basis-point jump has been identified. This unexpected shift has the potential to unsettle expectations, which could lead to a sense of panic within the Federal Reserve.
It is important to note, however, that market-based expectations can often be inaccurate and should not be treated as infallible predictors. Predicting the state of the world a decade from now is an impossible task, and these expectations are simply educated guesses that form part of a larger puzzle.
One of the challenges faced by the Federal Reserve is that even when inflation is generally trending downwards, Americans can still feel its impact. This sentiment is reflected in a recent survey conducted by the Census Bureau.
As long as other indicators of inflation expectations, such as the New York Fed’s survey, remain relatively stable, policymakers can cautiously maintain their comfort with current breakeven levels. However, it is important to keep in mind that this assessment may change depending on future developments.
We can anticipate the next significant update on U.S. inflation with the release of the consumer-price index for October, scheduled for next Tuesday. This report will provide valuable insights into the current state of inflation.
At the time of writing, Treasury yields and U.S. stocks, including DJIA, SPX, and COMP, were experiencing a general decline. This decline comes ahead of a $40 billion auction of 10-year government notes.