Inflation expectations seem to be under control
The stabilisation in long-end inflation swaps is an interesting development that sheds light on the rapid rise in developed markets interest rates. Taking the example of EUR (HICP) inflation swaps, the curve implies this inflation index will stabilise nicely in line with the ECB’s 2% target over the longer term. Investors by and large see the upcoming monetary tightening campaigning as successful in reining inflation in.
This is as all the potential drivers of a durably higher inflation (green transition, de-globalisation, etc.) are far from disproven. As usual, markets may be guilty of forming their long-term expectations based on near-term developments. The stabilisation in commodities prices might thus in part explain the moderation long term in inflation swaps, but there do not appear to be concerns about runaway inflation.
Flatter yield curve, but risk sentiment is holding up
For now, front-end rates continue to rise in accordance with a more hawkish Fed tone. Even as central banks aren’t likely to shift tone before spot inflation is on a downward path, the signal sent by inflation swaps is that there are only so many hikes needed to keep inflation under control. For now, this is likely to translate into flatter yield curves, with euro rates also tipping into a bear-flattening regime. The peak in long-end rates is further ahead, it will probably have to wait until medium-term growth fears crystalise. In the US, this could take the form of more housing market worries (see events section below).
This all means the 10Y US could test 2.75% to the upside, while the 10Y Bund reaching 0.7% is within the realm of possible outcomes, mostly dragged higher by US markets. The main risk to our view is a deterioration in sentiment. Geopolitics are still high on the list, but more broadly, sharp rises in rates have had a tendency to generate their own risk-off reactions. The indicator to watch here is real rates; they’re still historically low, but the speed of any sell-off is typically an adverse development for risk appetite. Taking 10Y USD swaps as an example, there is still 80bp to go before real rates reach 0%; this could prove unnerving for other markets.
Today’s events and market view
The main economic data releases coming out today are from the US: house prices, consumer confidence and job openings. The most interesting will be the impact of higher energy prices on consumer optimism. The drop in the University of Michigan index last week is an ominous sign. Job openings are expected to still be a multiple of available workers, while housing prices will be closely watched amid worrying signs about the housing market.
Of the European Central Bank, Luis De Cos is scheduled to speak.
Peace talks between Ukraine and Russia resume today in in Turkey. Encouraging headlines yesterday evening comforted markets in their optimistic take on the odds of further escalation.
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