US Inflation Will Soon Demand Greater Market Focus

Authored by Simon White, Bloomberg macro strategist,

With the increasing likelihood that the conflict in the Middle East will be a more drawn out affair, the market has amped up its focus on the geopolitical and energy implications. US inflation expectations, however, remain complacent.

Using Bloomberg’s NT function we can gauge interest in topics.

The percentage of stories on Bloomberg mentioning Iran and Oil has expectedly exploded since the US-Israeli strikes began. But there has been no uptick to speak of in mentions of inflation.

Indeed, as far as this measure is concerned, interest in inflation peaked in the aftermath of the Ukraine war, just after US CPI itself peaked in mid-2022.

That seems to me remiss, but it’s in keeping with what the fixing swap curve anticipates.

CPI is currently expected to rise sharply to about 3.5% in a few months, before trending lower to about 2.8% in a year’s time, i.e. only about 40 basis points above spot.

Breakevens too are relatively benign, with the two-year point up about 35 bps since the conflict began, and the 10-year only about 10 bps.

But a lot has to go right for inflation to match these expectations.

The war will still have to be relatively short; Iran won’t continue to aggravate shipping in the Hormuz strait even after the US and Israeli cease hostilities; and the second-round effects from higher energy prices, especially on food, will be limited.

On top of that, you probably have to bargain that the next Fed chair will act decisively if inflation does look like it’s going to become a problem again. The jury is very much out on that, which leaves real rates as sitting ducks.