In prior posts, we noted that inflation indicators and assets that are positively correlated to inflation have been increasing. In February, we also noted that our long-term view is that inflation and economic growth will return to levels similar to pre-2020. We are finally seeing that in some market-based measures of inflation.
One way to measure market participants’ expectations for inflation is to look at breakeven levels. Breakeven rates are a measure of the rate of future inflation that would make the return on a nominal investment equal to the return on an inflation linked investment. Currently, breakeven rates are higher for shorter time periods, meaning that inflation expectations in two years are higher than five and ten years. The spread between the five-year and ten-year measures is at a record level.
Another form of market-based inflation expectations is inflation swaps. Swaps are a contract where each party agrees to make and receive a type of payment. In this example, one party pays a fixed rate and the other pays an inflation-adjusted rate. This inflation rate is what investors expect inflation will be over certain intervals of time in the future. Like the breakeven rates, five-year inflation swap rates are currently higher than ten-year rates.
These market-based indicators of inflation suggest that the acceleration we are expecting in 2021 is more likely a reflection of weak comparisons to 2020 and supply constraints. Once these are no longer having an impact, the long-term rate of inflation will likely decline back towards the levels experienced prior to 2020.
Vice President, Research and Strategy
Boyd Watterson Asset Management, LLC
The views expressed herein are presented for informational purposes only and are not intended as a recommendation to invest in any particular asset class or security or as a promise of future performance. The information, opinions, and views contained herein are current only as of the date hereof and are subject to change at any time without prior notice.