Inflation Risks Are Now Even More Woefully Underpriced

Authored by Simon White, Bloomberg macro strategist,

TIPS have burst into life after Donald Trump’s win, with breakevens up over 10 bps, but the market is still to fully reflect extant inflation risks that have been exacerbated by the result of the election.

Donald Trump’s victory wasn’t necessary to stoke inflation in the US, but it helps. Price growth has become entrenched and the fabled last mile of disinflation is becoming a marathon. Resilient growth, strong corporate-profit margins, burgeoning stimulus in China and a nigh-on $2 trillion US fiscal deficit had already set inflation on a path of revival. If Trump governs as expected – tariffs, tax cuts, more spending - price-growth risks have only intensified.

But the market is downplaying the inflation outlook. Only about 40% the move in yields today comes from breakevens. CPI fixing swaps, i.e. the market’s expectations of CPI over the 12 months, have barely budged.

Granted they’re less liquid and may move through the day. But it’s a similar message if we look at SOFR options. The probability of an inflation tail is still low - taking that to be the Federal Reserve is forced to raise rates such that they are above 4.75% in December 2025 (i.e. assuming they cut rates 25 bps at Thursday’s meeting as expected, and then have to raise them again next year).

The probability has been rising, but is still only a little over 10%.

Sitting here today it might seem if would take a lot to force the Fed to raise rates again next year.

That may seem true, but when the distribution of outcomes is as wide as it is now, and inflation is already proving sticky, 10% looks too cheap.

TIPS continue to look like one of the best assets to hedge against rising inflation on a risk-adjusted basis.